Are Direct Labor & Direct Material Variable Expenses?

If you own your own business or are responsible for running someone else’s company, you’ll have to separate your production costs into various categories before you can analyze how well your business is doing and determine if you need to adjust the price of the products your business sells.

Whether you should classify your company’s labor and material costs as fixed or variable depends on if they are direct or indirect expenses. Getting these numbers correct will help you with your cash flow planning and management. It will also help you with your post-production analysis of your operations.

What are Direct Expenses?

Direct costs are expenses that can be easily traced or connected to the items your business produces or the services it provides, explains Your company’s direct material expenses are the costs of the consumable things that you need to produce the items your business sells.

If, for example, your company makes aluminum cans, the metal you purchase and shape into cans will be consumed as your production continues and is clearly related or traceable to the cans your business produces. As a result, the cost of the aluminum is a direct material expense.

If your labor cost is directly related to the production of the items your business makes, it is a direct cost, too. Your direct labor cost will equal the amount of money you pay to the employees and contractors who are immediately responsible for the physical production of the items your business sells.

What Are Indirect Expenses?

Unlike direct costs, indirect costs are expenses that are necessary for your business, but not directly related to your company’s production of goods or provision of services, according to Examples of indirect costs are the amount your business pays in rent, the depreciation of your company’s equipment and the property taxes your business pays.

What Are Variable Expenses?

A variable expense is one that increases and decreases in concert with your company’s production level, meaning it goes up when your business makes more of the items it sells and decreases when your business produces fewer units.

Since you will generally need to order more materials and pay for increased labor when you increase your company’s output, and purchase fewer materials and cut back on your employees’ hours when you slow production down, your direct labor and direct material costs are variable expenses.

What Are Fixed Expenses?

Similar to how direct costs are intimately related to variable expenses, indirect costs are interrelated with your company’s fixed expenses. Fixed expenses are the costs your business incurs that are not dependent on the number of saleable units your company makes, meaning your fixed expenses will be the same regardless of whether your business produces 10 units or 100,000 pieces.

Examples of fixed expenses include rent or mortgage, loan payments, insurance premiums and management salaries. Many business bookkeepers and accountants classify recurring expenses, such as electric, gas and water utilities, as fixed expenses, even though they vary each month.