What is the difference between direct labor and indirect labor?

When forecasting or managing your business finances, it's important to understand between direct labor and regular labor (indirect labor). Understanding how these labor costs are categorized helps ensure accurate reporting and more meaningful financial insights.

Labor costs refer to the total compensation paid to employees for their work. These costs are typically divided into two categories based on their relationship to the production of goods or services:

• Direct Labor: Costs directly tied to the creation of products or the delivery of services.
• Indirect Labor: Costs associated with support roles or operational functions not directly tied to production.

What is Direct Labor?

Direct labor includes wages paid to employees who are actively involved in producing a product or delivering a service. These roles are directly responsible for revenue-generating activities and are variable costs, meaning they change based on production volume.

Examples of direct labor roles:

• Assembly line workers
• Baristas in a coffee shop
• Hairstylists in a salon
• Technicians providing repair services

These labor costs are included in the Cost of Goods Sold (COGS), allowing you to analyze gross profit more accurately.

What is Regular (Indirect) Labor?

Regular labor, or indirect labor, refers to the wages of employees who support the business but are not directly tied to production or service delivery. These are generally fixed costs, meaning they remain relatively constant regardless of output levels.

Examples of regular labor:

• Administrative assistants
• Human resource managers
• Accountants
• Marketing and sales teams

Regular labor is treated as an operating expense, impacting your company’s overall profit margin but not directly contributing to COGS.

Why Keep Direct and Regular Labor Separate?

We separate these two labor types to give you a clearer financial picture:

• Direct labor refers to employee wages directly tied to delivering your product or service. These are forecasted under Direct personnel costs inside the Cost of Sales. This allows you to calculate your gross margin accurately and understand how efficiently your team is delivering value.
• Indirect labor includes salaries for administrative, support, or general business roles. These costs are entered under Personnel Expenses within Personnel. Since they are not directly linked to production volume, they impact your net profit but not COGS.

This separation provides a clearer view of your operating costs vs. production costs, helping you plan more effectively as your business grows.

Where does this entry appear in the financial statements?

In the Profit & Loss report:

• Direct labor appears under Personnel Costs (Direct Labor) within the Cost of Sales category.
• Indirect labor shows up under Payroll Expense (Indirect Labor) within the Operating Expense category.