Just starting out in a new business? To make sure your business runs efficiently, you need to familiarise yourself with a number of accounting terms and understand how these are used (by yourself as a business owner and your accountant) in your financial records.
Accounting for your expenses is an important part of the financial ‘work’ of your business. Do you know the distinction between ‘direct’ and ‘indirect’ expenses and why they matter to your business? Simply put, all the costs in your business make up the direct and indirect expenses in your business:
- Direct expenses are related the production of a specific product or service such as equipment and raw materials. Direct expenses can be variable as the numbers of any particular element can change over time. For example, the number of production units on the factory floor each month.
- Indirect expenses include any other expenses that go towards your production costs but are not specific to a certain product or service. You could say that they are related to the cost of maintaining your business. A simple way to define these expenses are those expenses that are ‘left over’ after the business’ direct expenses have been accounted for. Examples of indirect expenses include accounting, audit, and legal fees, office expenses, rent, marketing campaigns, and utility expenses such as electricity. Indirect expenses can be fixed or variable.
Employee cell phones are a good example of an indirect expense – as a business owner, you might give your employees cell phones to use at work so that you can communicate with them. These devices (and their contracts) add value to your business but they are not tied to a specific product or service that your business produces. Rather, they are linked to the overall running of your business, making them an indirect expense.
Why is it important to understand the difference between these two types of seemingly similar expenses? When you correctly allocate your costs, you can maintain proper financial records (essential to the successful running of your business) and ultimately remain legally and tax compliant, not to mention profitable!
Understanding your indirect expenses can also have major tax implications for your business. Not only is it necessary to classify your expenses to remain tax compliant, you could benefit from tax deductions for certain indirect expenses such as the utilities needed to power your business, especially if you run your business from home. If you do, it is important to remember that not all your expenses will be tax deductible just because you run your business from home. Instead, there are certain requirements that must be fulfilled around the use of the specific room or area used for business in your home and the use of the resources within it.
Expenses that directly relate to the work space are deductible in full, while indirect expenses can be partially deducted as are related to the cost of the property where the office is based. Not sure how this works for your business? Talk to an expert tax consultant to make sure your business is on the right track when it comes to tax compliance.
Want to make sure your business is running smoothly on the financial front? Chat to us – as accounting and tax professionals, we can help you with your record keeping, accounting tasks, and business plan.