The Difference Between Direct Expenses and Indirect Expenses
Business leaders aiming to steer their company’s financial ship would do well to understand the difference between direct and indirect expenses, and why now is a great time to review indirect.
Direct costs tie to specific projects or products — usually a company’s bread & butter. For example, the materials behind a new product offering would be considered a direct expense. These expenses “follow” the product through development, production, and sales.
Indirect expenses provide essential infrastructure and support. While tricky to attribute to one area, they enable progress across departments. For instance, software services, shipping costs, facilities maintenance and utilities would fall under indirect costs.
- Traceability: Direct purchasing ties tightly to products; indirect hover overhead across divisions.
- Predictability: Direct expenses align somewhat with production forecasts. Indirect throw budgeting curveballs.
- Controllability: Direct, like materials and labor, adjust easier short-term. Indirect prove more stubborn.
- Allocation: Direct pin completely to a department or project. Indirect necessitate consistent division across units.
How Much $ Goes to Each?
As you would expect, the amounts spent on direct and indirect expenses as a proportion of a company’s overall costs varies. It is effected by the industry, business model, size of the company, and other factors.
Direct Expenses: In manufacturing businesses, direct expenses (like raw materials and labor directly involved in production) can form a significant portion of the costs, often ranging from 50% to 70% or more of total expenses. In service-oriented businesses, this percentage might be lower since such companies may have less reliance on raw materials and more on labor and skills.
Indirect Expenses: Indirect expenses, which include costs like SaaS, Freight, and Printing, to name a few, can vary widely. In many companies, they might account for 30% to 50% of the total costs. This range is broad because indirect costs encompass a diverse range of expenses, and their impact differs based on the company’s scale, operational efficiency, and the nature of the industry.
Indirect Adds Up
Though elusive, indirect expenses carry weight – often 30% of total expenses. Trimming just 10% unearths boosts in profitability. But don’t axe too deeply; businesses will always have some “financial ghosts” to operate successfully. A 3rd party procurement consultant like ACC can help shed light on indirect and improve procurement transparency.
In navigating direct versus indirect costs, think ingredients vs. kitchen equipment. Visible ingredients build tangible products that raise revenue. Behind the scenes, that kitchen infrastructure powers it all.
Balancing direct and indirect appropriately takes financial finesse. Teams with a handle on their of overhead costs and tail spend gain an edge over their competition while keeping stakeholders happy and showing good financial stewardship.
Synonyms for Indirect Procurement
While not one-to-one match, there are a lot terms procurement teams use interchangeably for indirect spend. Here are some we hear often:
- Indirect Spend: Expenses incurred for goods and services that support business operations but are not directly tied to a specific product or service.
- Indirect Costs: Costs that cannot be directly attributed to the production of goods or services.
- Indirect Expenses: Purchases necessary for day-to-day functioning of a business, but not directly linked to core products or services.
- Operating Expenses (OpEx): Regular, ongoing costs involved in the operation of a business, including indirect spend.
- General and Administrative Expenses (G&A): Costs associated with managing and operating a business that are not directly linked to manufacturing or selling.
- Overhead Costs: Broad expenses that support the overall business operations but are not directly associated with specific products or services.
- Sundry Expenses: Miscellaneous expenses that do not fit neatly into other categories, often minor in nature.
- Tail Spend: The portion of spend that is not actively managed or strategically sourced, often composed of a large number of suppliers but a small percentage of total spend.
- Non-Core Expenses: Costs for goods and services that are not central to the company’s primary business operations.
- Miscellaneous Expenses: Varied and assorted expenses not classified under specific categories.
- Non-Strategic Spend: Expenses not critical to the core strategic operations of a business.
- Secondary Spend: Expenditures that are not the main focus of procurement activities, often representing a smaller part of total spend.
- Sundry Costs: Various small and irregular expenses essential for day-to-day operations, but not categorized under specific departments.
- Discretionary Spend: Expenses that are not essential for core operations and can be reduced or eliminated without impacting primary business functions.
Teamwork Makes the Dreamwork
If you could use help sorting though your indirect expenses and improving transparency, ACC would love to help. Drop us a note to get started: [email protected]