Indirect costs

Published Thursday 23 July 2026

Table of contents

• What is an indirect cost?
• Examples of indirect costs
• Indirect costs vs direct costs
• Are indirect costs the same as overhead?
• How to allocate indirect costs
• Why indirect costs matter
• Track your indirect costs with Xero
• FAQs on indirect costs
• Related terms
• Learn more about indirect costs

Key takeaways

• An indirect cost is a cost you can't trace directly to one product, service or project, so it supports your whole business instead.
• Indirect costs are often called overhead, and they can be fixed or variable.
• Direct costs go straight into what you sell, while indirect costs keep the business running in the background.
• To price and budget accurately, you spread indirect costs across your products or jobs using an allocation base such as headcount or floor space.

What is an indirect cost?

An indirect cost is a cost you can't trace directly to a single product, service or project. A direct cost goes straight into what you make or sell, but an indirect cost supports your whole business rather than one item.

Indirect costs are often called overhead. They can be fixed, like rent, or variable, like some utilities that rise and fall with how busy you are.

Examples of indirect costs

Indirect costs cover the everyday running expenses that keep your business open, even when you're not making a sale. Here are common examples for a small business:

• Rent for your premises
• Power, water and other utilities
• Wages for admin, back-office and sales staff
• Business insurance
• Marketing and advertising
• Merchant and card processing fees
• IT and software subscriptions
• Depreciation of shared equipment

Indirect costs vs direct costs

The difference comes down to traceability, or how easily you can link a cost to one thing you sell. A cost is either direct or indirect, never both. A direct cost ties to a specific product or job, while an indirect cost is shared across many:

• Direct costs: trace to one product, service or job, such as raw materials or the labour to build a specific item
• Indirect costs: support many products or the whole business, such as rent or insurance, so you can't tie them to one sale

Are indirect costs the same as overhead?

Yes, indirect cost and overhead usually mean the same thing: the shared running costs you can't trace to one product or service. You'll hear both terms used across accounting and everyday business talk.

Indirect costs can be a fixed cost that stays the same each month, like insurance, or a variable cost that moves with activity, like electricity. Knowing which is which helps you plan for busy and quiet periods.

How to allocate indirect costs

To work out what a product or job really costs, you spread your indirect costs across them using an allocation base. An allocation base is a fair measure of what drives the cost, such as headcount, floor space or machine hours. Here's a simple way to do it:

1. Choose an allocation base that reflects what drives the cost.
2. Add up the total indirect cost you want to spread for the period.
3. Work out each product or job's share of that base.
4. Apply the share to the cost to get each one's portion.

Say your workshop rent is $2,000 a month and product A uses 60% of the floor space while product B uses 40%. You'd allocate $1,200 of rent to product A and $800 to product B.

Why indirect costs matter

Indirect costs are easy to overlook because they don't sit inside any single sale, yet they shape your profit. If you price only to cover direct costs, overhead can quietly eat your margin.

Tracking indirect costs helps you set prices that cover the full cost of doing business, see your true profitability and build a budget you can trust. For a New Zealand small business, that clarity makes it easier to stay cash-flow positive and plan ahead with confidence.

Track your indirect costs with Xero

When your indirect costs sit in one place, you can see exactly what it takes to keep your business running and price your work to match. Xero categorises your expenses and reports on them in real time, so overhead never catches you off guard. Try Xero and get one month free.

FAQs on indirect costs

Here are answers to some frequently asked questions about indirect costs for small business owners.

What is an example of an indirect cost?

Office rent is a classic example, since it keeps your business running but can't be tied to one product you sell. Insurance and software subscriptions are common too.

Is an indirect cost the same as overhead?

In most cases, yes: overhead is another word for the shared costs you can't trace to a single product or service. The two terms are used interchangeably in accounting.

Are indirect costs fixed or variable?

They can be either, depending on the cost. Rent tends to stay fixed each month, while utilities often vary with how much you use.

How do you allocate indirect costs?

You pick an allocation base such as floor space or staff numbers, then split the cost across your products or jobs based on their share. This gives each one a fair portion of your overhead.

Related terms

• Direct cost
• Fixed cost
• Variable cost
• Overhead
• Operating expense
• Expenses

Learn more about indirect costs

• Managing overhead costs
• Business cost saving ideas
• Create a small business budget
• Measure profitability