Indirect costs

Published Wednesday 12 August 2026

Table of contents

• What are indirect costs?
• Examples of indirect costs
• Direct costs vs indirect costs
• Fixed, variable and semi-variable indirect costs
• How to calculate and allocate indirect costs
• Why indirect costs matter for your business
• 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 are general business expenses that support operations but cannot be traced to a single product, service or project.
• Common examples include rent, utilities, insurance, administrative salaries and office supplies.
• Tracking indirect costs helps you set accurate prices, protect profit margins and maintain healthy cash flow.
• You can allocate indirect costs using methods such as labour hours, machine hours or activity-based costing.

What are indirect costs?

Indirect costs are general business and administration expenses that are not directly tied to producing a product or delivering a service. They cannot be traced to a single cost object, such as a specific job, project or unit of output.

For South African small business owners, indirect costs often include expenses that keep the business running day to day, from office rent and electricity to accounting fees and software subscriptions. These costs support the entire operation rather than any one product line or customer order.

Examples of indirect costs

Indirect costs vary by industry, but most small businesses share a core set of ongoing expenses. Here are common examples you might recognise in your own accounts:

• Rent or lease payments for office, warehouse or retail premises
• Utilities such as electricity, water and internet
• Business insurance premiums
• Salaries for back-office and administrative staff
• Sales and marketing expenses
• Office supplies and stationery
• Professional fees, including accounting and legal services
• General software subscriptions
• Merchant and transaction fees
• Depreciation of general equipment

Direct costs vs indirect costs

Understanding the difference between direct and indirect costs helps you price your products and services accurately. Direct costs can be traced to a specific cost object, while indirect costs support the business as a whole.

Consider a courier or transport business. Fuel used to deliver parcels is a direct cost because it links directly to each delivery job. Fuel used by a manager driving to a client meeting is an indirect cost because it supports the business generally, not a specific delivery.

A cost is either direct or indirect for a given cost object. The same expense may be classified differently depending on what you are measuring. For a deeper look at direct costs and how they affect your gross profit, see the guide on calculating cost of sales.

Fixed, variable and semi-variable indirect costs

Indirect costs behave differently depending on your level of activity. Understanding these patterns helps you plan budgets and forecast cash flow. For more on managing ongoing expenses, read about what overheads are and how to manage them.

• Fixed indirect costs: these remain the same regardless of output, such as monthly rent or annual insurance premiums.
• Variable indirect costs: these fluctuate with business activity, such as merchant fees that rise when you process more card payments.
• Semi-variable indirect costs: these have a fixed base plus a variable component, such as a utility bill with a standing charge and usage-based charges on top.

How to calculate and allocate indirect costs

Allocating indirect costs lets you understand the true cost of each product, service or project. The basic formula for an indirect cost rate is:

Indirect cost rate = total indirect costs ÷ allocation base

Follow these steps to calculate and apply an indirect cost rate:

1. Identify all indirect costs for a set period, such as a month or quarter.
2. Choose an allocation base that reflects how resources are consumed, such as labour hours, machine hours or floor area.
3. Divide total indirect costs by the allocation base to get your rate.
4. Apply the rate to each cost object based on its share of the allocation base.

Several approaches exist for allocating indirect costs. A fixed classification method assigns the same amount to each cost object. Proportional allocation distributes costs based on a measurable factor. Activity-based costing assigns costs according to the activities that drive them, offering greater accuracy for complex operations.

Why indirect costs matter for your business

Indirect costs affect your bottom line even when they are not linked to a specific sale. Ignoring them can lead to underpriced products, squeezed margins and unexpected cash shortfalls.

Your pricing must cover both direct and indirect costs to remain profitable. If indirect costs rise without a matching price adjustment, profit margins shrink. Tracking these expenses gives you clearer insight into measuring profitability and helps you spot opportunities for increasing profit.

Indirect costs can also hide in plain sight. Without regular review, small expenses accumulate and erode cash flow before you notice.

How to reduce indirect costs

Lowering indirect costs improves your profit margins without requiring higher sales. Start by reviewing expenses regularly and questioning each line item. For more ideas, explore the guide on cost-saving ideas for your business.

• Review indirect costs monthly or quarterly to catch unnecessary spending early.
• Negotiate better terms with suppliers and service providers.
• Automate administrative tasks to reduce time spent on manual work.
• Share premises or downsize to cut rent and utility bills.

Track your indirect costs with Xero

Keeping indirect costs visible is easier when your accounting software organises expenses automatically. Xero helps you categorise transactions, generate reports and monitor spending trends so you can make informed decisions. Start tracking your indirect costs today and get one month free.

FAQs on indirect costs

Below are answers to common questions about indirect costs.

Is depreciation a direct or indirect cost?

Depreciation on general equipment, such as office furniture or computers, is typically an indirect cost. Depreciation on machinery used solely to produce a specific product may be treated as a direct cost.

Are indirect costs fixed or variable?

Indirect costs can be fixed, variable or semi-variable. Rent is usually fixed, merchant fees are variable and utility bills are often semi-variable.

Can a cost be both a direct and an indirect cost?

The same expense may be direct for one cost object and indirect for another. For example, a supervisor's salary is direct to the department but indirect to each product made by that department.

What is the difference between indirect costs and overheads?

The terms are often used interchangeably. In practice, overheads usually refer to ongoing operating expenses, while indirect costs is the broader category that includes any cost not traceable to a single cost object.

How do you calculate indirect costs?

Add up all expenses that cannot be traced to a specific product or service. Divide the total by an allocation base, such as labour hours, to find the indirect cost rate you can apply to each cost object.

Related terms

• Expenses
• Cash flow
• Profit and loss statement
• Assets

Learn more about indirect costs

• Cost of goods sold (COGS)
• Gross profit margin
• Start-up costs