Direct vs indirect costs: what small businesses miss

Key takeaways

Direct costs can be traced to a specific job, product or customer. Indirect costs cannot, so they are shared across the business. For a small business, the difference matters because most in-house support work is an indirect cost, and indirect costs are where inefficiency goes unnoticed.

• Direct costs trace to one job, product or customer.
• Indirect costs are shared: admin, IT, marketing and management time.
• Direct costs are checked against the price every time you quote.
• Indirect labour at £19.81 an hour: 10 hours a week is about £9,100 a year.

What is the difference between direct and indirect costs?

A direct cost is a cost incurred for one specific job, product or customer, such as materials or a subcontractor's fee. An indirect cost supports the business as a whole and cannot be traced to a single job, such as rent, software or the time of an office manager. The same person can create both, depending on what they are doing.

• The hidden costs of doing everything in-house
• What are hidden costs in a business?

What are examples of each in a UK small business?

The split depends on the business, but these examples hold for most UK service and trades firms.

• Direct: materials, subcontractors, billable staff hours, delivery, job-specific travel.
• Indirect: rent, insurance, software, accountancy, marketing, recruitment.
• Indirect labour: admin, reception, bookkeeping, IT support, management and unbilled owner time.

• Overhead cost per employee in the UK: what to add

Why do indirect costs hide inefficiency?

Indirect costs hide inefficiency because nobody compares them with output. A direct cost is checked against a job's price every time you quote. An indirect cost is paid monthly whatever happens. If a skilled employee spends a quarter of their week on admin, their salary has quietly moved from direct to indirect, and the accounts will not tell you.

A full-time employee on £30,000 costs about £19.81 per worked hour under 2026/27 GOV.UK rates. Ten hours a week of that person's time on unbilled support work is about £9,100 a year of indirect labour.

• The true cost of an employee in the UK
• Wearing too many hats at work: the cost to a small team

How do you allocate indirect costs?

Allocate indirect costs by spreading them over the thing that drives them. The simplest method is a rate per billable or productive hour: total indirect costs for the year divided by total productive hours. A more accurate method assigns costs by activity, such as cost per invoice raised or per enquiry handled.

• Total your indirect costs for the last 12 months.
• Total productive or billable hours for the same period.
• Divide to get an indirect cost per productive hour.
• Add that rate to direct cost when pricing a job.

• Activity based costing for small businesses

When does the distinction not matter?

For a sole trader with simple pricing and healthy margins, a detailed split adds little. It starts to matter when margins are tight, when you price by the job, or when you are deciding whether a support function should be done in-house or by a provider.

• In-house vs outsourcing: which model is more cost-effective?

How does indirect labour grow without anyone deciding?

Indirect labour grows one task at a time. A new reporting requirement, a second sales channel, a customer who wants invoices in a particular format: each adds minutes to somebody's week. Nobody approves the total, because no single addition looks like a cost. After a few years a business can find that a third of its payroll is support work, without ever having hired a support person.

The check is simple. Once a year, estimate the share of each person's time that is not spent on customer work, multiply by their loaded cost and add it up. Compare the figure with the previous year. If it is rising faster than revenue, hidden cost is building.

• Diseconomies of scale: when a bigger team costs more

What mistakes do small businesses make with indirect costs?

The commonest mistakes come from treating indirect cost as fixed and unavoidable, when a good part of it is a choice.

• Pricing jobs on materials and direct labour alone.
• Treating the owner's unbilled hours as free.
• Charging every job the same overhead, whatever admin it needs.
• Adding support headcount without checking utilisation.
• Reviewing supplier bills closely and staff time never.

What does this look like in practice?

A pattern we see in trades and construction firms: jobs are priced on materials and labour, and the office is treated as a fixed overhead. When indirect labour is spread across jobs, small jobs often turn out to lose money, because each one carries the same quoting, scheduling and invoicing effort as a large one.

• See client work
• BPO Solutions for UK businesses

Direct and indirect cost checklist

Use these steps once a year.

• Tag every cost line as direct or indirect.
• Estimate the share of each person's time that is unbilled.
• Calculate indirect cost per productive hour.
• Check your prices cover it.
• List indirect tasks that could be done more cheaply.

• The hidden cost audit: score your business in an hour

Next step

Send us a rough split of your team's time. We will help you work out your indirect cost per productive hour in a 30-minute call.