Indirect costs

Published Monday 31 August 2026

Table of contents

• Indirect costs (definition)
• Examples of indirect costs
• Indirect costs vs direct costs
• Types of indirect costs
• How to calculate and allocate indirect costs
• Why tracking indirect costs matters
• How to reduce indirect costs
• Track your indirect costs with Xero
• FAQs on indirect costs
• Related terms
• Learn more about indirect costs

Key takeaways

• Indirect costs keep your business running but can't be traced to one product or service, and are also called overheads or administrative costs
• Direct costs are tied to what you sell, while indirect costs support the whole business
• Tracking indirect costs helps you set prices that protect your profit margin and your cash flow
• You can lower indirect costs by reviewing your profit and loss statement and renegotiating supplier contracts

Indirect costs (definition)

Indirect costs are the expenses that keep your business running but can't be traced to a specific product or service. They're also called overheads or administrative costs, and they cover the day-to-day running of the whole business.

Examples of indirect costs

Indirect costs show up across both service and product businesses, covering back-office admin as well as selling and marketing. Grouping them makes it easier to track your business expenses and see where money goes.

• Office rent, utilities and supplies
• Administrative salaries, such as bookkeeping and reception staff
• Accounting software and other subscriptions
• Insurance and professional fees
• Marketing, advertising and sales activities
• Depreciation on office equipment and vehicles

Indirect costs vs direct costs

Direct costs can be traced to a specific product, service or job, while indirect costs support the business as a whole. Direct costs feed into your cost of goods sold, and indirect costs sit separately as overheads.

Take fuel as an example. Fuel for a courier company's delivery run is a direct cost, because it's tied to the service the customer pays for. Fuel for the owner's admin trip to the bank is an indirect cost, because it supports the business rather than a specific job.

Types of indirect costs

Indirect costs behave differently as your activity changes, which affects how you budget for them. They usually fall into fixed, variable and semi-variable types, and you can read more about these in the guide to business overheads.

• Fixed: costs that stay the same regardless of output, such as office rent
• Variable: costs that rise and fall with activity, such as sales commissions
• Semi-variable: costs with a fixed base plus a usage element, such as an electricity bill with a standing charge

How to calculate and allocate indirect costs

Most indirect costs are easy to total because they come straight from invoices and contracts, such as rent agreements and insurance policies. Depreciation is the exception, since you calculate it by spreading an asset's cost across its useful life.

To spread indirect costs across your products or jobs, work out an overhead rate. You divide total indirect costs by an allocation measure, then apply that rate to each product or job.

1. Add up your indirect costs for the period
2. Choose an allocation measure, such as labour hours or units produced
3. Divide total indirect costs by the allocation measure to get your overhead rate
4. Apply that rate to each product, service or job

For example, if you have ₱600,000 of indirect costs and 3,000 labour hours, your overhead rate is ₱200 per hour. A job that takes 10 hours then carries ₱2,000 of indirect costs.

Why tracking indirect costs matters

Indirect costs sit below your gross profit and reduce your net profit, so ignoring them can make a business look healthier than it is. When you leave them out of your prices, you eat into your net profit margin.

Clear visibility of these costs also protects your cash flow. Knowing what leaves your account each month helps you plan for quiet periods and set prices that cover the full cost of doing business.

How to reduce indirect costs

Small changes to your overheads can lift your profit without needing more sales. Start with your reports, then work through your suppliers and admin for more cost saving ideas.

• Review your profit and loss statement to see where the money goes
• Renegotiate contracts with suppliers and service providers
• Automate admin tasks like invoicing and bank reconciliation
• Cut discretionary spending that adds little value

Track your indirect costs with Xero

Xero brings your bills, expenses and reports into one place, so you can see your indirect costs clearly and act on them before they eat into your margin. Sign up and get one month free to start tracking every peso of overhead.

FAQs on indirect costs

Here are quick answers to common questions about indirect costs and how they work for small businesses.

What is an example of an indirect cost?

Office rent is a clear example, because you pay it whether or not you make a single sale. Accounting subscriptions and business insurance work the same way.

What is the difference between direct and indirect costs?

A direct cost can be traced to one product or job, such as materials for a customer order. An indirect cost supports the whole business, so it can't be pinned to a single sale.

What are indirect costs in a business?

They're the running costs that keep the doors open, such as rent, utilities and admin salaries. Every business carries them, even on days with no sales.

What are the two types of indirect costs?

The two main types are fixed costs, which stay steady, and variable costs, which move with your activity. Semi-variable costs combine both, with a fixed base plus a usage charge.

Related terms

• Direct cost
• Fixed cost
• Variable cost
• Expense

Learn more about indirect costs

• Cost of sales
• Start up costs
• How to measure profitability