Indirect cost

Published Wednesday 30 September 2026

Table of contents

• What is an indirect cost?
• Indirect costs vs direct costs
• Types of indirect costs
• Examples of indirect costs
• How to calculate indirect costs
• How to allocate indirect costs
• Indirect costs in grant funding
• Why indirect costs matter for your business
• Tips for managing indirect costs
• Keep your indirect costs in check with Xero
• FAQs on indirect costs
• Related terms
• Learn more about indirect costs

Key takeaways

• An indirect cost supports your whole business but can’t be traced to a single product or job, such as rent or admin salaries
• Direct costs feed into cost of sales and gross profit, while indirect costs are overheads that reduce operating profit
• Divide total indirect costs by an allocation base to find your indirect cost rate, then apply it to every job so your prices cover overheads
• Revenue lets you deduct indirect costs incurred wholly and exclusively for your trade, while equipment is claimed through capital allowances

What is an indirect cost?

An indirect cost is an expense that keeps your business running but can’t be traced to a single product or job. It supports your operations as a whole.

Picture a bakery. The flour in each loaf is a direct cost because you can tie it to that product. The rent on the bakery benefits every item you sell, so it’s an indirect cost.

You’ll often hear them called overhead costs. Accountants call the thing you’re costing a cost object, such as a product or a customer. An indirect cost is shared across several cost objects at once.

Indirect costs vs direct costs

According to AccountingTools’ comparison of direct and indirect costs, only direct costs trace to a specific cost object, while the rest are shared. The split also shapes your margins. Direct costs feed into your cost of sales and gross profit, while indirect costs are overheads that reduce operating profit.

What are direct costs?

A direct cost is an expense you can trace straight to a specific product or project. If you stopped making that item, the cost would go away. Common direct costs include:

• raw materials and supplies used in production
• wages for staff who work directly on a product or project
• delivery costs for finished goods
• equipment bought for one specific job

How to tell them apart

Ask yourself: “If I stopped making this product, would this cost disappear?” If yes, it’s a direct cost. If it stays because it supports the wider business, it’s indirect.

Say you’re a freelance graphic designer. A stock image licence bought for one client’s project is a direct cost of that job. Your broadband bill supports every client, so it’s indirect.

Can a cost be both direct and indirect?

Yes, because it depends on what you’re costing. Heating for your whole building arrives on one bill, so it’s an indirect cost to each department and gets shared out by floor space.

A supervisor’s wages work the same way. If they only manage your production floor, their wages are a direct cost of that department. They’re still an indirect cost of each product made there.

Types of indirect costs

These costs behave differently as your workload changes. Sorting them by type makes budgeting easier.

Fixed indirect costs

Fixed costs stay the same however busy you are. You’ll pay them in a quiet month and a record month alike. Examples include:

• office or warehouse rent
• business insurance premiums
• salaries for administrative staff
• annual software subscriptions

Variable indirect costs

Variable costs rise and fall with your level of activity. The more you produce or sell, the higher they climb. Examples include:

• utility bills that grow with production
• office supplies used faster in busy periods
• repairs that increase with equipment use
• consumables for shared machines, such as oil and cleaning fluid

Semi-variable indirect costs

Some costs have a fixed part and a variable part, which makes them harder to predict. A phone plan might charge a set monthly fee, plus extra when your team goes over its allowance.

A company van works the same way. The lease payment is fixed, while fuel varies with how often it’s on the road.

Examples of indirect costs

Shared costs turn up in every corner of a small business. These are the categories you’re most likely to see.

Facility and operating expenses

These are the costs of having a place to work. They include:

• rent or mortgage payments for your premises
• electricity, gas, water and broadband bills
• building maintenance and repairs
• cleaning and security services
• depreciation of equipment and vehicles

Administrative costs

Administrative costs cover the people and systems that keep your business organised. Common examples include:

• salaries for office managers and human resources (HR) staff
• accounting and bookkeeping fees
• legal and professional services
• office supplies like paper and postage

Technology and software

Most businesses rely on tools that support every part of the operation. These include:

• cloud accounting software subscriptions
• customer relationship management (CRM) tools
• cybersecurity and data backup services
• IT support and hardware maintenance

Insurance and compliance

Protecting your business brings its own ongoing costs, such as:

• employers’ liability and public liability insurance
• professional indemnity insurance
• business property and contents insurance
• licence and permit fees

Citizens Information’s guide to becoming self-employed explains that business insurance isn’t a legal requirement in Ireland. It does advise public liability cover if the public visits your premises. Employers often take out employers’ liability cover too, because they owe staff a duty of care under the Safety, Health and Welfare at Work Act 2005.

Marketing and sales overhead

Marketing that promotes your brand as a whole is usually an indirect cost. Examples include:

• website hosting and maintenance
• general advertising
• social media management
• trade show stands and sponsorships

How to calculate indirect costs

The most common way to calculate indirect costs is to find your indirect cost rate, which shows how much overhead each unit of work carries. Follow these four steps to work out your own rate.

1. List your indirect costs

Pull every indirect expense for the period from your accounts, such as rent and admin salaries. Group related costs into cost pools, for example a facilities pool and an admin pool. You can then share out each pool using the base that suits it.

2. Choose an allocation base

An allocation base is the measure you use to share out overheads. Pick the one that best reflects what drives these costs:

• direct labour hours, for service businesses where staff time drives the work
• machine hours, for manufacturing and production-heavy businesses
• floor space, for sharing facility costs across departments
• direct labour cost, when you want the rate as a percentage of wages
• total revenue, for businesses with a wide mix of product lines

3. Divide to find your indirect cost rate

Divide your total overheads by the total of your allocation base for the same period. Here’s the formula:

Indirect cost rate = total indirect costs ÷ allocation base

4. Apply the rate to each job

Multiply the rate by the amount of the allocation base each job uses. When you track time and costs against each project, you’ll have the figures ready for every quote.

A worked example in euro

Say your business has €60,000 in indirect costs for the year, and your team logs 4,000 direct labour hours. €60,000 ÷ 4,000 hours = €15 per direct labour hour.

So every hour of direct work carries €15 of overhead. A job that takes 20 direct labour hours picks up €300 in indirect costs (20 hours × €15).

Expressing the rate as a percentage

Using direct labour cost as your base gives you the rate as a percentage. Divide the same €60,000 by €150,000 of direct labour cost, and your rate is 40%.

A job with €2,000 of direct labour cost would then carry €800 of overhead (€2,000 × 40%).

How to allocate indirect costs

Once you know your total overheads, you need a way to spread them across your products or departments. The right method shows you the true cost of everything you sell.

Equal-split allocation

This is the simplest method: you divide your shared costs equally among your products or departments. It works best when each one uses roughly the same share of overhead.

For example, €12,000 of monthly overheads split across four departments gives each one €3,000.

Proportional allocation

Proportional allocation shares out running costs based on each department’s slice of a chosen measure, such as revenue or labour hours. If Department A earns 60% of revenue, it takes 60% of the shared costs, and Department B takes the other 40%.

Activity-based costing

Activity-based costing (ABC) is the most detailed method. The Corporate Finance Institute (CFI) guide to activity-based costing describes how it works. You link overheads to the activities that cause them, then charge products for the activities they use.

If customer support is a big overhead, for instance, ABC would count the support calls each product generates and share costs accordingly. It takes more effort to set up, and in return gives you the most accurate view of your costs.

Indirect costs in grant funding

If you apply for grants, you’ll usually need to show how you’ll cover overheads, because each funder sets its own rules. EU research funding is a useful example for Irish businesses.

Under Horizon Europe, the European Commission’s guidance for applicants covers indirect costs with a flat 25% of eligible direct costs. Subcontracting and internally invoiced goods and services are left out of that calculation, as they already include overheads.

Other Irish and EU schemes may use different rates or ask for actual costs. Check each scheme’s own rules before you build overheads into a grant budget.

Why indirect costs matter for your business

Your running costs touch almost every financial decision you make. Here are four areas where they matter most.

Pricing your products and services accurately

If you price using direct costs alone, you risk undercharging. Building your indirect cost rate into every quote means your prices cover overheads and protect your margin.

There’s one exception. AccountingTools’ guide to indirect costs points out that you can often leave them out of special orders and short-term pricing decisions. You’d pay those overheads whether or not you take the work.

Filing your taxes correctly

In Ireland, Revenue lets you deduct business expenses from your trading profits when they’re incurred wholly and exclusively for your trade. That test comes from section 81 of the Taxes Consolidation Act 1997, as explained in Revenue’s Tax and Duty Manual. Everyday indirect costs like rent, utilities, insurance and software subscriptions usually qualify.

Capital purchases such as equipment are claimed through wear and tear allowances instead. Revenue’s capital allowances guidance sets the rate for plant and machinery at 12.5% a year over eight years. Sole traders claim the same rate under section 284 of the Act.

Sole traders report these costs on Form 11 through the Revenue Online Service (ROS), while companies file Form CT1. Tracking indirect costs through the year makes either return quicker to prepare.

Making better financial decisions

When you can see where your overhead goes, it’s easier to spot ways to cut costs or invest with purpose. If your technology spend is rising faster than your revenue, for example, it’s a good time to review your subscriptions.

Securing business funding

Lenders and investors want to see that you understand your full cost structure. A clear breakdown of your direct costs and overheads in your financial statements makes your business case stronger.

Tips for managing indirect costs

Keeping overheads under control protects your profit while keeping quality high. Start by using accounting software to categorise every overhead as it comes in, so you’re working from real figures each quarter.

Review your running costs once a month and look for anything that’s risen without a clear reason. These habits help keep overheads lean:

• renegotiate supplier contracts each year
• combine software tools where one can do the job of two
• move to cloud-based tools to cut hardware and maintenance costs
• automate repetitive admin tasks to free up staff time
• review insurance policies annually so your cover matches your needs

Set a target indirect cost rate and track it over time. If it starts creeping up, look into the cause early, before it eats into your profit.

Keep your indirect costs in check with Xero

Getting your overheads clear now means sharper quotes and a smoother tax return later. Xero pulls in your bank transactions automatically and turns them into easy-to-read reports. You can categorise each overhead and watch your cash flow in real time.

Sign up today and get one month free to see exactly where every euro goes.

FAQs on indirect costs

Here are quick answers to common questions about indirect costs.

Are indirect costs the same as fixed costs?

Indirect means you can’t trace a cost to one job, while fixed means it stays the same as activity changes. Rent is both, but utilities are indirect and variable.

What’s the difference between overhead and indirect costs?

The terms are often used interchangeably. Some people keep overhead for ongoing running costs like rent, and use indirect costs for the wider group that also takes in one-off shared expenses.

Is depreciation an indirect cost?

Usually, yes, when the asset is shared, like office computers or a pool van. Depreciation on a machine that only makes one product can be charged to that product as a direct cost.

Can indirect costs be tax-deductible?

Yes, Revenue allows most day-to-day overheads when they’re wholly and exclusively for your business. You’ll need to keep the supporting records for six years.

Do sole traders have indirect costs?

Yes. Your phone bill and accounting software support every job you do. Spread them across your billable hours to set an hourly rate that covers them.

Related terms

• Gross profit
• Net profit
• Expense
• Assets

Learn more about indirect costs

• How to increase profits
• Cost of goods sold (COGS)
• How to track business expenses
• Startup business costs
• Cash flow forecasting