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A cost is the amount a company spends to make a product or deliver a service.

Based on their nature, costs can be classified as either direct costs or indirect costs.

Consider Max Manufacturing, a bicycle manufacturer.

It incurs direct costs, which are expenses that can be clearly linked to bicycle production.

These costs include direct materials, such as raw materials, and direct labor, such as wages paid to workers whose labor can be directly traced to production.

If the company produces one hundred bicycles each month, it spends eighteen thousand dollars on materials and seven thousand dollars on direct labor.

On the other hand, if it manufactures two hundred bicycles, the direct costs for materials and labor also double.

The company also incurs indirect costs, such as factory rent, equipment maintenance, and utility bills.

These costs support the business, but they do not change in the same way as direct costs when production increases.

By correctly classifying and assigning these costs, the business gets a clearer picture of its true production expenses.