Direct costs are important to businesses, consumers and investors. Direct costs have a direct impact on margins, profitability, product and service prices, and the growth potential of a company. Learn more about this issue!
What are direct costs? Definition of the term
Directcosts are costs that directly translate into a product or service. Direct costs can be incurred by an enterprise in the normal course of business, such as the purchase of raw materials, materials, energy or services. Direct costs can also be incurred by an enterprise as part of marketing activities, such as advertising or promotion.
Direct costs are important for both businesses and consumers. For businesses, direct costs have a direct impact on margins and profitability. The higher the direct costs, the lower the margins and profitability. For consumers, direct costs have a direct impact on the prices of products and services. The higher the direct costs, the higher the prices.
Direct costs are also important to investors. Investors look at a company’s direct costs to assess whether the company is efficient and has growth potential.
What counts as direct costs?
Within direct costs, we can distinguish between material costs and personnel costs. Material costs include the cost of purchasing raw materials needed to make a service or product. Personnel costs, on the other hand, are all costs related to the employment of employees, their salaries, as well as training and development.
Direct costs – examples
Let’s explain with an example what direct costs are. These are expenses that directly contribute to the product or service. What direct costs can we distinguish?
Direct costs include, among others:
- material costs – these are all costs that are directly related to the raw materials needed to produce a good or service. Thus, in the case of furniture production, a direct cost would be the wood that is needed to make the furniture,
- employee compensation costs – these are all expenses related to the employment of employees who contribute to the production of a given product or service. Thus, in the case of furniture production, a direct cost will be the wages of the carpenter who is responsible for making the furniture.
- Energy costs – these are all costs that are directly related to the consumption of energy in the production process. Thus, in the case of furniture production, the direct cost will be the electricity needed to operate the carpenter’s tools,
- depreciation costs – these are all costs that are related to the purchase and operation of equipment needed to produce a good or service. Thus, in the case of furniture production, the direct cost will be the depreciation of carpentry joinery.
Also find out what indirect costs are.
