There are two types of expenses in your business….
Author: Russell SmithJune 16, 2015
There are two types of expenses. There are (jargon alert) ‘cost of sales’ and ‘overheads’. Cost of sales or sometimes called ‘direct costs’ are those costs in the business that directly impact the sales. For example, if you are making pens, then ink would be a direct cost. If you are run a restaurant, food will be a direct cost Direct costs are directly attributable to sales which means if your sales go up, your direct costs should go up. If your sales go down, then your direct costs will go down.
Overheads are costs that happen whether or not you are making sales. A good example is rent. If you move into an office or warehouse but you don’t actually do any work or production, you still have to pay your landlord. It’s the same with your IT supplier, accountant and other fixed costs. They are fixed because they are going to happen with no relation to your sales. The trick with overheads is not to get them too high especially in the early days.
There is a cost that is in-between ‘cost of sales’ and ‘direct costs’ and that is your team i.e. wages and salaries. This can be an overhead since you have to pay your team whether or not you make any sales but at the same time, if you are a service company such as a marketing agency then your team would be a direct cost since they generate sales.
To add to the confusion (in your Companies House year-end accounts that your accountant will prepare, this cost would appear in ‘overheads’).
To make it simple, if you are a service company (you are selling services rather than products) then I would put them in direct costs (except for the admin staff, put those in overheads). However, if you make a product, put all team costs in overheads.