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Direct and indirect costs

Which costs belong to one unit, which are shared across all of them, why size is no guide, and how to total a unit's direct cost.

Paper packet. Every task here also exists on screen, where it is checked automatically; answers written on paper are not assessed by Nydus. When you are back at a device, enter your answers there.

1. What you will learn

You will take any cost a business pays and say whether it is direct — traceable to one unit — or indirect, shared across all of them, using one test that works the same in a workshop, a kitchen, a market stall and a repair bench. You will also total the direct cost of a unit from a costing sheet, say what that total leaves out, and explain why the same cost can be direct to a product line and indirect to one item.

2. What you already have

You can already list what your business spends money on: the materials, the rent, the phone, the fuel, the fees. That list is the raw material for everything in this course. What it has not got yet is a shape, and without a shape it cannot answer the question every owner has to answer first — what does one of the things I sell actually cost me? This lesson makes the first cut through the list, and every later lesson depends on it.

3. Words this lesson uses

4. Which unit does this cost belong to?

Direct or indirect is a question about tracing, not about size. A cost is direct when you can say which unit it belongs to without arguing; indirect when the only honest answer is all of them.

The test is one question, asked of one cost at a time: would this money have been spent if this one unit had never been made or sold? No means direct; it would have gone anyway means indirect. A card fee on one sale is direct; the rent is indirect. Neither verdict is about importance — calling a cost indirect only says it must be spread before it reaches a price, which is lesson 7.

Always name the unit before you test. The same cost can be direct against one unit and indirect against another. A kiln rented only for a line of mugs is direct to the mug line and indirect to one mug, because every mug in the line shares it. Most confusion about direct and indirect is two people costing two different units without saying so.

5. The method, step by step, and how to check it

Sorting a spending list takes five moves, and each has a reason.

Name the unit. Write it down as one thing: one lunch box, one clean, one repair. A list costed against the business has no direct costs at all, because everything belongs to the business.

Ask the tracing question of each line. Would this money have left the account if this one unit had never been made or sold? Ask it of the actual payment, not of the category: the fuel to one client's house is direct to that clean, while the van's insurance, also a vehicle cost, is indirect.

Treat a divided cost as indirect. If the only way to give a unit a figure is to divide a bill — the rent over the month's units, the software over the month's orders — the cost is indirect, however exact the division looks. The figure you get depends on the method and on the volume you assumed; a direct cost depends on neither.

Add the direct lines. The total is the unit's direct cost. Label it as that and nothing more.

Check the total. Two checks catch most mistakes. First, no monthly or yearly bill should appear in one unit's direct cost at its full amount: if the direct cost of one mug is larger than the rent, the rent has slipped in. Second, the direct cost should be less than the price the unit sells for; if it is not, either the price is wrong or a shared cost has been counted as direct. A third check is to change the volume in your head: double the units sold this month and ask which lines on the sheet would change for one unit. The direct lines stay exactly as they are; only the shares of shared bills move. If a line you marked direct would move, it was an allocation all along.

6. A costing sheet, filled in

One lunch box, in dollars.

The direct total is 3.60 and the whole list is 5.50: about a third of this box's cost is outside the direct figure. Both indirect lines say share, and a share is a method, not a measurement. If the kitchen sells twice as many boxes next month, the oven lease share halves and the direct cost does not move — which is the practical difference between the two columns.

7. Why the cut matters before any price is set

Direct cost is the floor under a price. Sell a unit for less than its direct cost and every sale makes the business poorer, whatever the volume: no amount of selling covers a loss on each unit. Indirect cost is different. It is paid once for the period, so its effect on one unit falls as the volume rises, and the right volume can carry it.

That is why an owner deciding whether to accept a one-off job — a bulk order at a lower price, a favor for a regular — first compares the offer with the direct cost. If the price covers the direct cost and the job uses capacity that would otherwise sit idle, it adds something toward the rent. If it does not, it is a gift. Later lessons turn this comparison into contribution and break-even; the cut you make here is what they are built on.

8. In the world: pricing a wedding cake

A home baker is asked to quote for a three-tier wedding cake, and the first thing she needs is its direct cost. She lists what the cake alone will use: 18 dollars of flour, butter, eggs and sugar; 26 dollars of fondant and decorations; 14 dollars for the cake boards, dowels and box; and a 9-dollar delivery charge to the venue. Every one of those would not be spent if the couple went elsewhere, so the direct cost is 18 + 26 + 14 + 9 = 67 dollars.

Her other costs are real but shared: the oven's electricity for the month, the kitchen's insurance at 45 dollars a month, and the 30-dollar monthly fee for the website where couples find her. None of them changes because of this cake. If she baked 15 cakes last month, a rough share of the 75 dollars of insurance and website is 75 ÷ 15 = 5 dollars a cake, but that figure is an allocation: in a month of 5 cakes it would be 15.

Keeping the two apart shapes the quote. Anything under 67 dollars loses money on the cake itself, whatever else happens. The shared costs, and her own twelve hours of work, must be covered by the price as well — which is why her quote will be several times the direct cost — but she knows exactly which part of the price is paying for what.

9. In the world: a restaurant's food cost

Restaurants track food cost: the direct cost of the ingredients on a plate, as a share of the menu price. A burger with 3.40 of beef, bun, cheese and garnish, sold at 12, has a food cost of 3.40 ÷ 12 ≈ 28%. Many restaurants watch this percentage week by week, because it is the part of each sale that goes straight back out with the plate.

Rent, the kitchen staff's wages and the dining room's heating are not in food cost: they are shared across every plate and are paid whether the room is full or empty. A kitchen that confused the two — putting a share of rent into each plate's food cost — would see its food cost rise in a quiet week, when nothing about the burger had changed, and would chase a problem in the ingredients that was really a problem of volume.

10. Where this goes wrong

Big costs must be direct. The rent is the largest thing you pay and it is indirect; a twenty-cent card fee is direct. Size has nothing to do with it.

Indirect means ignorable. It is money that left the account, and a price not carrying its share loses on every sale.

It can be split, so it is really direct. Dividing the rent by the units makes it allocated: the figure then depends on the method you picked and the volume you assumed, and a direct cost depends on neither.

A service has no direct costs. A clean uses fuel and supplies; a repair uses parts; a consultation may use a room booked for it. Test the payment, not the trade.

Direct and variable are the same thing. Two cuts through one list. A kiln rented for one product line is direct to that line and fixed; shared lighting is indirect and variable. Pricing a job needs the direct cut and break-even the variable one, so collapsing them breaks both.

11. One mug at Maya's Ceramics

1. Name the unit and list what the studio pays.

   $\text{unit} = \text{one mug}; \quad \text{clay } 2.00, \text{ glaze } 0.40, \text{ box } 0.35, \text{ kiln rent } 300 \text{ a month}$

   Direct or indirect is measured against one named unit.

2. Test the clay.

   $\text{clay } 2.00 \Rightarrow \text{direct}$

   Had that mug never been thrown, the clay would still be in the sack.

3. Test the glaze and the box.

   $\text{glaze } 0.40, \text{ box } 0.35 \Rightarrow \text{direct}$

   Both are used on this mug and no other; being small does not change that.

4. Test the kiln rent.

   $\text{kiln rent } 300 \Rightarrow \text{indirect}$

   It is 300 at one mug or none, so it is shared by every mug.

5. Add the direct costs and label the result.

   $2.00 + 0.40 + 0.35 = 2.75 \text{ direct}$

   This is what a mug costs directly, not what a mug costs: the kiln is still to be spread.

12. One clean at Bright Home Cleaning

1. Name the unit.

   $\text{unit} = \text{one clean at one address}$

   Nothing is manufactured, so owners often conclude there are no direct costs; start with the test, not the trade.

2. Test the fuel to that address.

   $\text{fuel } 4.00 \Rightarrow \text{direct}$

   It is not spent on a canceled booking.

3. Test the cloths and solution used on the job.

   $\text{supplies } 3.00 \Rightarrow \text{direct}$

   They are used up at this address.

4. Test the insurance and the phone line.

   $\text{insurance } 40, \text{ phone } 15 \text{ a month} \Rightarrow \text{indirect}$

   Both are paid in a week with no bookings at all.

5. Add the direct costs.

   $4.00 + 3.00 = 7.00$

   A service has direct costs like anything else.

6. Name what the figure leaves out.

   $7.00 \text{ excludes the owner's two hours and the shared bills}$

   The owner's time is costed in lesson 6; say what a figure omits so nobody prices from it alone.

13. A kiln that is direct to one thing and indirect to another

1. Maya rents a second kiln for 240 a month, used only for her line of large bowls. She makes 60 bowls a month. Name the first unit.

   $\text{unit} = \text{the bowl line for the month}$

   The same cost can be tested against a whole line or against one item, and the answer depends on which.

2. Test the kiln against the bowl line.

   $\text{kiln } 240 \Rightarrow \text{direct to the bowl line}$

   Without the bowl line the kiln would not be rented at all.

3. Now name one bowl as the unit and test again.

   $\text{unit} = \text{one bowl}: \quad \text{kiln } 240 \Rightarrow \text{indirect}$

   The kiln is paid whether this one bowl is made or not; every bowl shares it.

4. Find one bowl's share by dividing.

   $240 \div 60 = 4.00 \text{ a bowl}$

   A figure reached by dividing is an allocation, and it depends on the 60.

5. Show that the share moves with volume.

   $240 \div 80 = 3.00 \text{ a bowl}$

   Make 80 bowls and the share falls, while the clay in each bowl does not change.

6. Add the bowl's own direct costs: clay 5.50 and glaze 1.10.

   $5.50 + 1.10 = 6.60 \text{ direct to one bowl}$

   Only the costs one bowl alone caused are in this total.

7. Write both figures with their labels.

   $6.60 \text{ direct}; \quad 6.60 + 4.00 = 10.60 \text{ with the kiln share at 60 bowls}$

   Two honest figures, each labeled, instead of one that hides an assumption.

14. Your turn: one crate at Monica's Market Stall

1. Name the unit and test the wholesale crate at 20 dollars.

   $\text{unit} = \text{one crate}; \quad 20 \Rightarrow \text{direct}$

   It would not have been bought without this crate being sold.

2. Test the pitch fee of 150 for the month.

   $150 \Rightarrow \text{indirect}$

   It is paid at one crate or eighty.

3. Your turn: work this step out. Its working is at the end of the packet.

   Test the 0.60 card fee on the crate's sale, and add the direct costs.

15. Guided practice

Neighborhood Kitchen sells lunch boxes. Sort each cost by whether it belongs to one box or to all of them.

16. Guided practice

Complete the worked solution: one repair uses a part costing $7$ dollars and supplies costing $1$, carries a card fee of $2$, and is given a share of $2$ dollars of the month's rent. What is its direct cost, and what is its cost once the rent share is added?

1. Name the unit being costed.

   $\text{unit} = \text{one repair}$

   Direct or indirect is always a question about one named unit.

2. Sort the four lines by the tracing test.

   $\text{part, supplies, card fee: direct}; \quad \text{rent share: indirect}$

   The first three would not be spent without this repair; the rent is paid whatever comes in.

3. Add the direct lines.

   $7 + 1 + 2 =$ _d

   The direct cost is the sum of what this one repair caused.

4. Add the rent share to see the cost with its share of the indirect.

   $(\text{direct}) + 2 =$ _t

   The rent is real money that the price must also carry, once it has been spread.

5. Label each figure with what it is.

   $\text{direct cost} \ne \text{full cost}$

   A figure without its label invites someone to price from the smaller one.

17. Guided practice

Northside Repairs replaces a phone screen. The screen costs $36$ dollars, the adhesive and wipes used on that phone cost $2$, the card fee on the sale is $2$, and the bench in the back of the shop is rented for $48$ a month. What is the direct cost of this one repair, in dollars?

Answer:

18. Practice

One unit uses $7$ dollars of materials, $3$ dollars of packaging and a $3$-dollar delivery charge for that order. The business also pays $182$ dollars a month for rent and $75$ dollars a month for its phone line. What is the direct cost of one unit, in dollars?

Answer:

19. Practice

A costing sheet for one unit. Say whether each cost is direct or indirect, then give the direct cost of one unit in dollars.

20. Practice

Neighborhood Kitchen sells lunch boxes. Sort each cost by whether it belongs to one box or to all of them.

21. Somewhere new

A photographer charges for a portrait sitting. For one client's order she spends $23$ dollars on prints, $6$ on the frame the client chose and $6$ on the courier who delivers it. She also pays $237$ dollars a year for the website that lists her work. What is the direct cost of that client's order, in dollars?

22. Lesson test

Lesson test: one question per skill, one attempt each, no hints. Your answers are checked when you submit.

23. Test question

A costing sheet for one unit. Say whether each cost is direct or indirect, then give the direct cost of one unit in dollars.

24. What you can do now

You can name one unit, ask whether a cost would have been spent without it, and sort a spending list into direct and indirect. Tell someone why the rent is indirect even though it is the biggest number you pay. Next: the other cut through the same list — fixed against variable.

Working for the steps left to you

14. Your turn: one crate at Monica's Market Stall, step 3