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Know your Numbers - Direct vs Indirect Costs


Hey! Do you ever feel like you need an accounting degree to understand the numbers in your business? The truth is you don't! Keep watching this video to find out more.

Whether you're running a contracting business by yourself, or if you have multiple employees, the key to running a successful contracting business is understanding your costs. And if you watched last week's episode, you'll know that I'm talking about costs in terms of managerial accounting, and not in terms of financial accounting. In our journey in calculating the markup unique to your business,

it's important that you understand a couple of concepts in managerial accounting. In particular, how managerial accounting classifies costs. The first cost classification is Direct Costs. These are costs that can be easily traced to a project. A great place to find these costs is in your estimate because when you estimate a job, you have to estimate all the costs directly attributable to that job

and you typically classify those costs into material costs, subcontractor costs, labor costs, and other, which could include permits and general condition costs. What about rentals? When you rent equipment, where does that go? Is that a direct cost? The answer to that question is it depends. If it's a once-off rental specific to that job, then it's a direct cost.

But if it's a rental that you plan to use on multiple jobs throughout the year, that is an Indirect Cost. Indirect costs are costs incurred regardless of the project happening. A great place to find these costs is underneath gross profit in your Profit & Loss Statement. Managerial accounting classifies these costs as overhead and examples of these costs include: truck, phone bills, advert expenses, and general liability insurance.

What about equipment rentals? Well, we touched on that point earlier under direct costs, but how about salaries? For example, the project manager or supervisor's salary and the business owner's salary.

We like to say, "keep things simple." So if you're just getting started, put those costs as overhead. As you start getting more comfortable with costing, and you're actually tracing the hours that your project managing and yourself spending on the job, then you can start allocating it as a direct cost.

You'll notice that I specifically said that the owner's salary is part of the indirect costs or overhead. The owner's salary is not the net profit and it's very important to remember that as we continue our journey in calculating the markup unique to your business. I hope you enjoy today's episode, and if you have any questions, please leave them in the comments below.

Thank you. Cheers.

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