How to Calculate Direct Cost
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What Counts as a Direct Cost
Direct cost is any cost that you can trace to one product, one job, or one service without guesswork. It includes direct materials, direct labour, and other direct expenses that belong to that item or project.
Examples make this clear. In a bakery, flour and sugar are direct materials, and bakers’ wages are direct labour. In a furniture shop, lumber and hardware are direct materials, and the joiner’s time is direct labour. In construction, concrete and steel are direct materials, and on-site crews are direct labour. By contrast, factory rent, office internet, and the CFO’s salary are indirect. You need them to run the business, yet you cannot tie them to one unit without a method.
Direct Cost vs Indirect Cost, Why the Difference Matters
Getting this line right affects pricing, margins, and your books. Direct costs set the floor for your price. Indirect costs sit in overhead and need recovery through markup or an overhead rate. Mixing the two will distort margin and lead to bad decisions. For a quick refresher, see this plain-English primer on direct versus indirect costs.
The Core Formula You Will Use Every Time
Here are the two formulas you need. These align with common accounting guidance for inventory costing in IAS 2 Inventories and the US GAAP overview of ASC 330 Inventories.
Total Direct Cost = Direct Materials + Direct Labour + Other Direct Expenses
Direct Cost per Unit = Total Direct Cost ÷ Units Produced
Mini example: A workshop makes 100 stools in April. Lumber and hardware cost 18,000. Direct labour is 12,000. Freight-in on that lumber is 1,000. Total direct cost is 31,000. Cost per unit is 31,000 ÷ 100, which equals 310 per stool.
Step-by-Step, Calculate Direct Cost for a Period
- Identify cost items. List all materials, direct labour roles, and other direct expenses that tie to your product or job.
- Collect quantities and rates. Pull quantities from bills of materials and purchase orders. Pull hours and rates from time sheets and payroll.
- Assign to jobs or batches. Tag each cost to a job number, order number, or batch. Avoid mixed buckets.
- Sum and reconcile. Add up each cost category. Check totals against your ledger and receiving logs.
- Compute per-unit cost. Divide total direct cost by units produced or by completed jobs to get a clear unit rate.
Keep a simple naming rule. Use job numbers everywhere, on PO lines, time sheets, and receiving notes. This creates a clean audit trail.
How to Treat Direct Labour Correctly
Direct labour includes wages for people who work on the product or service. Include their base pay, shift premiums, overtime tied to the job, payroll taxes, and benefits that vary with labour. Exclude general admin staff and managers who do not work on a specific job.
Use time tracking that records job number, start time, end time, and role. Multiply hours by the labour rate for that role. If you pay overtime for work on Job 2201, include that extra cost in Job 2201.
Other Direct Expenses, What You Can Include
These are costs that are not materials or wages, yet still tie to one job. Common items include freight-in for the raw materials of a job, special tooling consumed in one order, subcontracted steps that only serve that order, and royalties per unit if they apply to that product.
For more structure on what sits inside cost of inventories, review the scope and cost components in IAS 2. For US readers, PwC’s summary of ASC 330 is a helpful map to practice topics.
Document these with invoices and job numbers. If a cost serves many jobs, treat it as indirect unless you have a fair and direct trace to one item.
Examples Across Industries
Bakery
Direct materials include flour, sugar, yeast, butter, and boxes for a batch. Direct labour includes bakers and packers who work on that batch. Other direct expenses can include rush shipping of flour for a large order.
Furniture Workshop
Direct materials include lumber, screws, glue, and finish. Direct labour includes cutting, assembly, sanding, and finishing hours. Other direct expenses may include CNC tooling wear for a custom run.
Construction
Direct materials include concrete, rebar, lumber, and fixtures. Direct labour includes on-site crews. Subcontractors that work on that site count as direct. Jobsite permits often tie to the site, treat them as direct if they only apply once.
Software Services
Many costs are indirect, like office rent and general engineers’ salaries. What can be direct, project-billed developer hours, cloud resources spun up only for that client, and third-party API fees that only serve that project. For broader costing methods, see the CIMA study note on cost classification and costing.
Job Costing vs Process Costing
Job costing fits custom work. You collect materials and labour by job number, then compute that job’s unit cost.
Process costing fits continuous production. You pool costs for the period, then divide by equivalent units.
For a deeper dive into methods and exam-grade definitions, read CIMA’s overview of costing methods.
Job example: Job 310 uses 2,000 in materials and 1,500 in direct labour to make 5 prototypes. Total direct cost is 3,500. Unit direct cost is 700.
Process example: The plant spends 90,000 in direct costs to make 3,000 identical bottles in May. Unit direct cost is 30.
Pricing With Direct Cost, Margin, and Markup
Use direct cost to set a floor. Then add overhead recovery and margin. A simple path is to apply an overhead rate per labour hour or as a percent of direct labour. Then add a target margin.
For small businesses, the U.S. Small Business Administration has a brief on cost allocation and startup costs that can help you frame overhead recovery and pricing.
Example: Direct cost per unit is 50. Overhead recovery adds 20, which gives 70. You want a 30 percent margin. Price = 70 ÷ (1 − 0.30) = 100. Pricing covers both direct and indirect costs and delivers the margin you want.
Common Mistakes and How to Avoid Them
- Mixing indirect costs into direct. Keep rent, utilities, and admin out of direct cost. Recover them through overhead.
- Missing payroll burdens. Include payroll taxes and benefits that scale with direct labour.
- Ignoring scrap and waste. Track yield. If you scrap 5 percent of material, adjust your bill of materials or your expected unit cost.
- Double counting freight. Record freight-in once, either in materials cost for that job or as other direct expense for that job.
- Poor job tagging. Put job numbers on every document, from PO to time sheet.
Data Sources and Tracking Tips
Build your numbers from real documents. Use bills of materials for quantities, purchase orders and invoices for prices, receiving logs for what arrived, and time sheets for hours. Keep a short list of roles with standard rates. Review these rates each quarter.
For software projects, use your project system to log hours by task and client. For physical goods, link the bill of materials to the order. Small teams can track this in a spreadsheet if the sheet is clean and current. For a simple primer on small business cost structure, the SBA guide on startup and operating costs is a good reference.
Quick Worksheet, Fill-In Template
Final Thoughts
Keep the process simple. Identify costs, track them by job, sum them with care, then divide by units. Do this every period. Review changes in rates and yields. When you keep the data clean, pricing gets easier and your margin stays healthy.
