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Direct expenses are any types of expenses that are specifically related to the creation of a product or service. Expenses of this type may include the raw materials used in the manufacturing process, as well as labor costs associated with employees who manage the actual production. The classification of indirect and direct expenses is very important to the function of a business enterprise, not only in terms of managing operational costs but in some cases also in the calculation of taxes.
The key difference between indirect and direct expenses is that the latter is actively used in the production process. In contrast, the former has to do with managing costs that make it possible to accept and process orders, promote the product line, and generallly support the efforts of the manufacturing enterprise. Some examples of indirect expenses include sales and public relations efforts, research and development, and the maintenance of an organized accounting effort.
Accounting for direct expenses is a key element within any business. Failing to accurately keep track of the cost of raw materials, labor costs, and other expenses directly involved in the manufacturing effort can make it difficult to set unit prices for the products produced that are sufficient to cover those expenses. When this happens, the business may generate a great deal of sales, but ultimately not take in enough per unit to sustain the operation over the long-term.
Monitoring trends with indirect expenses is also important to the ongoing operation of a business. By tracking the unit costs associated with specific raw materials, it is possible to determine the impact of increases or decreases in those prices on the overall profitability of the business. Being aware of the shifts in costs makes it is possible to respond to those changes in a manner that is in the best interests of the company. For example, if a key raw material should increase significantly in unit price, identifying vendors that offer a similar material at a lower per unit rate may be a viable option that allows the business to continue marketing its products at the same rates, a move that in turn helps to keep the company competitive in the marketplace.
Every type of business will have both indirect and direct expenses. Even smaller operations like a locally owned auto repair will need to account for both types of costs within the accounting records. Some examples of direct expenses in this setting would be the auto parts purchased to aid in the repair of vehicles and the labor costs associated with the mechanics who actually conduct the repairs. At the same time, the shop would incur indirect expenses like the administrative personnel who schedule appointments with customers, any publicity campaigns conducted by the business, and even the costs associated with maintaining a comfortable waiting area that customers use while waiting for vehicle repairs to be completed.
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