Episode Transcript
[00:00:00] Welcome to another episode of Financial S Nickens. I'm your host, Elisa McCabe, and today we are talking about the exciting subject of direct and indirect costs. What are you saying, snore? No, no, no. They are really, really important and if you don't understand them, you will end up in trouble because you won't be charging enough for your product or service, and you won't have the profit that you need.
So, um, we're always searching for ways to increase profitability, and knowing these numbers is really going to help you price your product and allow you to have some profit. So, So direct expenses are expenses that are directly related to the sale of your product or service. So for example, if you own a flower shop, the flowers, the vases, the ribbons, the cards and the labor of putting the arrangement together are all direct [00:01:00] costs.
Now, If you are a law firm, anything that is related to serving your client, the labor that's involved, any supplies that are spent, all that is also a direct cost. If you own a toy store, I think you can guess that toys would be your direct cost. So I hope that gives you an idea of what your direct costs are.
So these direct expenses are gonna vary. In relation to how much you sell. So if you're a law firm and you have 10 clients, you're gonna have a direct cost associated with that. If you have 20 clients, that direct cost is gonna increase in proportion to the sales. So it makes sense that. If you sell more, those direct expenses will go up.
If you sell less, those direct expenses will go down. So in general, direct expenses are recorded as cost of goods sold. [00:02:00] There's some controversy in the accounting industry, um, about services being recorded as cost of goods sold. I like to do it that way. I actually record everyone on our team that produces services to our clients.
They are cost of goods sold. All of our accountants, our CFOs, they provide a service to our clients, so they're listed under cost of goods sold. Now, once you have those numbers in cost of goods sold, and you have your sales, you subtract off your cost of goods sold. That number that you get is called a gross profit margin.
Don't be afraid of these words. It's just how much you have left over to pay for the rest of your business. Now, what's the rest of the business? Indirect expenses, they are things that they cost to run your business, but they're not directly related to the item that you sell. So some examples will be like rent.
Or the telephone [00:03:00] or insurance or utilities or administrative labor such as, um, an admin person or maybe a supervisor who isn't actually producing the work. And then professional services fall into this in, uh, we call it below the line. So if you look at a profit and loss, you'll have your income, your cost of goods sold, and then your gross profit margin.
And then everything below that line is going to be your indirect costs. They're the costs of just running a business no matter what you're selling. So it would be legal, hr, it, accounting. We end up below the line, um, office supplies, hardware, anything that you need. Um, and so what ends up happening is you can look at.
What your direct costs are, what does it cost to run your business versus what your, your, your indirect costs versus your direct costs, which are the cost to [00:04:00] produce your product or service. So there's a great way to keep these numbers in mind because this might seem a lot. If you go into QuickBooks Online, and I'm sure every other soft accounting software has it, you go in and run a profit and loss by percent of income.
So in the first column, you're gonna have your profit and loss, and the second column, it's gonna be everything is going to be based off of your income. So your income is gonna be a hundred percent, and then the next number down will be your cost of goods sold. And, and having those numbers and knowing what are good numbers for you is important.
They're different by every industry. Cost of goods sold in my industry is different than in other industries, so you might have a cost of goods sold at 40%. That means that it costs you 40% of every sale to produce your [00:05:00] product. Okay? So that means you have 60%. Left to pay your bills. That sounds pretty good, right?
But if your expenses exceed the amount that you have left over to pay, then you aren't pricing your product right, or your indirect expenses are too high. So it gives you different places to look. So knowing the difference between direct, which are the things that you pay for to produce your product or service, and.
Indirect, which is the things to run your business day to day. Phones, rent. Those things that don't change, no matter how many, how much your sales are. Knowing the difference between those two is incredibly important because it'll keep you profitable if you're charging enough for your product and able to pay for your direct costs and cover your indirect costs and have money left over.
That's [00:06:00] really good. So if you have any more questions about indirect or direct costs or just how to price your product, head over to our website. First Steps financial.com and click on the Let's Chat button and we're more than happy to give consultations about pricing your product, how to stay profitable and how to keep some money for you at the end of the month.
You can also shoot me an email at alisa first steps financial.com, and I look forward to talking to.
