“Heigh-Ho, Heigh-Ho, it’s back to work we go.” – the Dwarf Chorus, Snow White and the Seven Dwarfs. 

Now that there is serious talk of the economy reopening post-shelter-in-place orders, it’s the perfect time to review your company expenses. It’s going to take a while before your revenue returns to normal, so let’s use this time to prepare. 

As you ramp up, you need to know where your money is going and what it is doing. Understanding your expenses will help you to judge when your company will fully recover.

There are two kinds of expenses – Indirect and Direct. If you are unsure which type you’re working with, ask yourself if you NEED this item or service to run your business. When your business can’t operate without it, it’s an Indirect Expense. When the cost is the result of a client’s project, it’s a Direct Expense.

Examples of Indirect Expenses

Indirect expenses are the costs associated with running your business -your overhead costs. They may be fixed fees like rent or variable costs like electricity. When we want to economize our bottom line, indirect costs are a good place to start. Ask yourself, “Is that something the business NEEDS or something I want?” If it is a WANT, consider delaying gratification by waiting a bit.

 Some examples of indirect expenses:

• Salaries
• Advertising
• Rent
• Janitorial costs
• HR consulting costs

Examples of Direct Expenses

Direct expenses are related to a client/project and attributed to the production of goods sold or services provided. These are your “Costs of Goods Sold” and vary from month to month as you complete various types of projects.  

Your company may have different direct expenses than those on the above list, depending on the focus of your business. Is your company a service business, a manufacturer or a retail store?

For example, a manufacturing company will have expenses related to the purchase of materials and the creation of the product they make.  

A plumbing company provides service and installs fixtures. The labor to install fixtures is direct labor associated with the specific project. We use the phrase “Parts and Labor,” which is another example of direct expenses.

Other examples of direct expenses:

• Raw materials
• Sales Commissions
• Purchase of goods for resale
• Direct labor

Classifying: It’s Black, White and Sometimes Gray

Some costs may not be as easy to classify as they fall into a gray area. For example, let’s say your company uses electricity for computers that track inventory, light your workspace, and to run the spiffy new coffee machine in the breakroom. Those are Indirect Expenses. 

You also use electricity to perform the services for which you get paid. That’s an example of Direct Expenses. Sometimes the distinctions between indirect or direct expenses can get murky.

Why Classify Expenses?

It is valuable to know the difference between Direct and Indirect expenses for your bookkeeper, sales staff, and especially for you, the owner. Your bookkeeper will want to differentiate so they are categorized correctly. “Cost of Good Sold” is a vital classification when reporting revenue. This information flows into the filing of taxes. It helps the accuracy of your bid when your sales staff knows the true costs of a project or service.

As a business owner, reopening a business after the virus shutdown, you need to know your reopening cost and your available income. Knowing the difference will help you adjust your yearly budget. As the owner of the business, being aware of the kind of expenses your business incurs enables you to judge the company’s overall health and plan a path forward.

I don’t know about you, but I’m just about done with self-quarantine. I want to know when those rascally seven dwarves can Heigh-ho their way back to work.