What are indirect costs? Definition and examples

Published Thursday 23 July 2026

Table of contents

• What are indirect costs?
• Examples of indirect costs
• Direct costs vs indirect costs
• Are indirect costs fixed or variable?
• How to identify and allocate indirect costs
• Why indirect costs matter for pricing and profit
• Are indirect costs tax deductible in the UK?
• How to manage indirect costs
• Take control of your business costs with Xero
• FAQs on indirect costs

Key takeaways

• Indirect costs are the general business and administration expenses that keep your business running but aren't tied to making a specific product or delivering a specific service.
• They're often called overheads, and common examples include rent, utilities, insurance, and software subscriptions.
• You need to spread indirect costs across what you sell and factor them into your prices, or they'll quietly eat into your profit.
• Most indirect costs are allowable business expenses for UK tax, but rules change, so check current guidance or speak to an accountant.

What are indirect costs?

Indirect costs are the general business and administration expenses that aren't directly linked to making products or delivering services. They're the money a business spends even when it's not selling goods or delivering services.

Indirect costs are also called overheads. Think of them as the background running costs that keep the lights on and the business ticking over, whatever your sales look like in a given month.

Examples of indirect costs

Indirect costs show up across almost every part of a business. Here are some of the most common examples you'll come across:

• Rent and office supplies
• Utilities such as electricity, gas, water, and internet
• Insurance
• Administrative and back-office salaries
• Sales and marketing
• Professional fees for accounting and legal support
• Software subscriptions
• Depreciation
• Merchant service fees for processing card payments

Direct costs vs indirect costs

The difference comes down to what a cost is for. A cost is either direct or indirect, never both.

Direct costs go straight into creating or delivering your products or services, like raw materials or the labour to make an item. Indirect costs are the background expenses of running the business, like rent and insurance, that support everything you do without being tied to any single sale.

Are indirect costs fixed or variable?

Indirect costs can be fixed, variable, or somewhere in between. What makes a cost indirect is whether you can trace it to a specific product, not whether it changes with output.

• Fixed indirect costs stay roughly the same each month, such as rent and insurance
• Variable indirect costs rise and fall with activity, such as some utilities and marketing
• Semi-variable indirect costs have a fixed base plus a variable element, such as a phone plan with usage charges

How to identify and allocate indirect costs

Spotting an indirect cost is simpler than it sounds once you know the test to apply. From there, you can spread those costs fairly across what you sell.

The test is one question: does this cost directly create your product or service? If the answer is no, it's likely an indirect cost. Rent passes as indirect because you'd pay it whether or not you made a single sale, while the timber for a table you're building is direct.

To allocate indirect costs, businesses often work out an overhead rate. You divide your total indirect costs by an allocation measure, such as direct labour costs or machine hours, then apply that rate to each product or job.

Say you have £10,000 of indirect costs to spread across 500 machine hours. That works out at £20 per machine hour, so a job that uses 10 machine hours carries £200 of overheads.

Why indirect costs matter for pricing and profit

Hidden indirect costs still have to be paid, and the money to cover them has to come from your prices. If your pricing only covers direct costs, your overheads will quietly erode your profit.

That's why you need a pricing strategy that covers everything, including the overheads that don't show up on any single invoice. According to Xero Small Business Insights, UK small business margins are being squeezed by energy and finance costs, with petrol prices up 15% in March 2026, so tracking indirect costs like utilities and fuel is more important than ever.

Getting this right also protects your cash flow, because you can see what you're really spending and price with confidence.

Are indirect costs tax deductible in the UK?

Most indirect costs can reduce your tax bill, though the detail depends on your circumstances. Here's the general picture.

Indirect costs incurred wholly and exclusively for business are usually allowable business expenses, which means you can deduct them when working out your taxable profit. Rules and definitions change, so check current HMRC guidance or speak to an accountant before you file.

How to manage indirect costs

Keeping indirect costs under control is an ongoing job rather than a one-off task. A few simple habits make a real difference to your bottom line.

• Review your overheads regularly to spot spending that's crept up
• Negotiate with suppliers on rent, insurance, and subscriptions
• Track your expenses with accounting software so nothing slips through

Cloud accounting software like Xero brings your expenses together in one place, so you can see where your money's going without digging through paperwork.

Take control of your business costs with Xero

Staying on top of indirect costs helps you price accurately, protect your margins, and make confident decisions about where to spend. When your overheads are organised and easy to see, there are no nasty surprises at the end of the month.

Xero brings your finances together in one place so you can track expenses, monitor cash flow, and understand your true costs, and you can get one month free when you sign up.

FAQs on indirect costs

Here are answers to some frequently asked questions about indirect costs.

What is an example of an indirect cost?

Rent is a classic example, since you pay it to run the business rather than to make a specific product. Utilities, insurance, and software subscriptions are other common indirect costs.

What is the difference between direct and indirect costs?

Direct costs go straight into creating or delivering a product or service, such as materials or production labour. Indirect costs support the whole business without being tied to any single sale.

Are indirect costs the same as overheads?

Yes, overheads is another word for indirect costs. Both describe the general running expenses of a business that aren't linked to a specific product or service.

Are indirect costs fixed or variable?

They can be either, and some are semi-variable. Whether a cost is indirect depends on traceability to a product, not on whether it changes with output.

Are indirect costs tax deductible?

Indirect costs incurred wholly and exclusively for business are usually allowable expenses you can deduct from taxable profit. Rules vary, so check current HMRC guidance or ask an accountant.