For a café, the direct costs are the food and the staff involved directly in making and serving that food. If you’re a builder working for yourself, it’s the materials you buy for the jobs you do and any labour or subcontractors you hire, plus the part of your wages spent physically working on contracts.
Why are direct costs so important? Because they should generally be about the same proportion to your sales.
So the café might expect food costs to be 33 percent of sales. If this percentage rises, the owner should be finding out why the change. Is it waste, portion control, not charging enough or what?
The more often you can measure your direct costs, the better control you will have over your business.
If you prepare two-monthly GST returns, take the opportunity to tweak these figures to find out how much your direct costs are as a percentage of your sales.
For some businesses, who have little stock, this will not be too difficult. Adjust your sales figures for money owing to you at the beginning and the end of the two months. Adjust your purchases figure for money owing by the business at the beginning and the end of the two months.
If you do this, you will probably get a reasonable idea of whether you’re keeping your direct costs under control.
Unfortunately, if you have large stock levels, you might need to count this every two months. It’s probably better to have a rough count than none at all.
There’s usually a limit to how much you can control the other business costs, such as rent, motor vehicle costs, insurance and so on. Focus on the direct costs. This is where wastage of materials and your staff time most easily occurs.
There are, naturally, always exceptions. Builders are an extreme example. One year there’s a really big contract with higher than normal direct costs and yet you get a good net profit! It’s usually because working regularly at the same site gives you much better productivity. Perhaps 90 percent of your time is spent building, whereas in a normal year you have to move around from job to job, or you have to spend more time quoting and less time building.