What is a direct cost?

Direct cost (definition)

Direct costs are expenses that are directly linked to the goods or services a business sells. They’re the opposite of indirect costs.

For most small businesses, a direct cost is also the cost of goods sold (COGS) or cost of sales (COS).

Examples of direct costs

  • Inventory or raw materials that make up what you’re selling
  • People working on manufacturing goods or delivering services
  • Leases and energy for dedicated workshops or factories

Businesses may have different views about whether or not to count workshop or factory expenses as direct costs. They may also disagree about whether or not to count freight and warehousing. The most important thing is to settle on a definition that works for your business, and then apply it consistently.

Why direct costs matter

It’s important to understand how sales create a knock-on increase in costs. A seasonal business, for example, will need to plan to have cash on hand for the busy time of the year. Similarly, a business that’s planning a big sales push will need to ensure they can afford to meet the increased demand.

How they differ from indirect costs

A cost is either direct or indirect. It can’t be both.

Indirect costs represent all the background expenses of running a business. That includes things like utilities, insurance, general admin, and costs associated with marketing and sales. Employees and facilities might be considered direct or indirect, depending on the type of business.

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This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.