Direct costs can be traced to a specific product, project, or service. If you build homes, the lumber for a particular house is a direct cost. The hours your crew spends framing that house are a direct cost. You know exactly which job consumed those resources.

Indirect costs support the business overall but can’t be assigned to one job. Your office rent, liability insurance, and the salary of your office manager who handles paperwork across all projects fall into this category. These costs exist whether you complete one job or twenty.

The distinction becomes clear with examples. A contractor buying plywood for a kitchen remodel: direct cost. That contractor’s general liability insurance: indirect cost. A restaurant purchasing beef for tonight’s menu: direct cost. The restaurant’s POS system subscription: indirect cost.

Labor can fall into either category. Electrician hours on a specific job are direct costs. The bookkeeper who processes invoices across all your projects is an indirect cost. Whether you handle payroll yourself or work with a San Diego payroll service, understanding where those labor dollars belong matters for accurate job profitability.

Why does this matter for your business? Knowing direct costs tells you the minimum you need to charge to avoid losing money on a specific job. Knowing indirect costs tells you what overhead must be covered by your total revenue. Price a job to cover only direct costs and you’ll stay busy while slowly going broke.

For construction companies and project-based businesses, tracking direct costs by job is essential. This is where construction job costing comes in. Every material purchase, labor hour, and subcontractor invoice gets assigned to the job it belongs to. Without this assignment, you can’t know whether a project actually made money.

Indirect costs get allocated across jobs using various methods. Some businesses use a percentage of direct costs. Others use a percentage of revenue or total hours worked. There’s no single right way. What matters is consistency and using a method that makes sense for your type of business.

In your accounting software, direct costs usually appear in Cost of Goods Sold or Cost of Services. Indirect costs show up in operating expenses or overhead categories. This separation affects how you calculate gross profit margin versus net profit margin and gives you different insights into where your money actually goes.