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Business Glossary

What Is a Direct Cost?

A direct cost is any cost that varies directly with the production or delivery of a product or service. Direct costs are deducted from revenue to calculate gross profit. Getting this distinction right is fundamental to accurate gross margin calculation.

The Formula
Gross Profit = Revenue − Total Direct Costs (COGS)
Worked Example — UK SME

A UK service business delivers a project for £12,000. Direct costs: freelance staff £3,800, project-specific software £420, materials £280. Total direct costs = £4,500. Gross profit = £7,500 (62.5%). Office rent and admin salaries are overhead — not direct costs.

UK Benchmark
📊 The key test: does this cost change if I produce one more unit or deliver one more project? If yes, it is a direct cost. If fixed regardless of output, it is overhead.
Common Questions
What are common direct costs for UK SMEs?
Manufacturing: raw materials, direct labour, packaging, freight, import duty. Retail/distribution: purchase cost of goods, inbound freight, import duty. Service: direct labour on specific projects, subcontractors, project materials.
What happens if I misclassify overhead as direct cost?
Your gross margin understates the true commercial value of each sale. Pricing decisions based on inflated direct costs lead to underpricing — you’ll think you need a higher margin than you actually do to cover overhead.
Is staff cost a direct cost?
Only if directly attributable to specific products or projects. A production operative’s wages are direct. A managing director’s salary is overhead. An account manager’s salary is overhead unless time is tracked at project level.

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Related terms
Fixed vs Variable CostsContribution MarginGross MarginGross ProfitAll 50 terms →