Calculating Realistic Startup Costs for Small Businesses
Starting a small business can be an expensive and complex process. A company needs to secure a permit, design a logo, conduct market research, create a website and social media account, and find an office to rent before its doors even open. Each of these tasks comes with a different price tag that depends on the type of business. Calculating all of these organizational costs and securing enough loans to cover them are an essential component of any business plan.
Determining startup costs aid in planning financials, estimating future profits, calculating growth rate, managing their cash flow and make money. Here is an overview of the different types of expected costs and how to best manage and calculate them.
What Are Startup Costs?
Because startup costs can vary depending on industry and size of the business, there is not a universal agreement on what constitutes a startup expense.
Broadly speaking small business startup costs are all of the expenses and assets incurred during the establishment of a new business.
Why Calculate Startup Costs?
Calculating startup costs is a key element of a financial plan or an overview of a company's current and projected financials. Benefits of calculating the initial working capital include-
- Helps secure loans from investors Investors will feel more comfortable giving out a loan when they have an accurate breakdown of costs.
- Easier to estimate profits Calculating startup costs makes it easier to accurately predict and estimate profits.
- Able to conduct a breakdown analysis of fixed costs Businesses who calculate expenses from the start know how many sales of products and services are needed each month to cover any costs associated with starting a small business.
- Know how to identify tax deductions Estimating costs help save money when it's time to pay local and federal taxes because certain expenses are eligible for tax deductions.
One-Time and Ongoing Common Startup Expenses
Business owners know that startup expenses are split into one-time costs and ongoing expenses, providing more accurate estimates of how much it costs to launch a business. Examples of one-time business costs include-
- Permits and Legal Fees A legal document issued by government agencies allowing businesses to operate within a certain geographical jurisdiction
- Incorporation Fees A filing fee required to form a company or corporate entity. Incorporation fees vary by state
- Logo Designs A graphic mark or visual utilized to identify a company and promote its brand
- Website Designs The costs incurred by creating and maintaining a company website
- Brochures or Business Cards Print publications utilized to highlight a company's benefits
- Signage Digital signage or traditional signage that is utilized as part of an overall marketing strategy
- Real Estate Costs Initial cost of a down payment for an office space as well as any required renovations
Ongoing business expenses refer to the continuous, long-term costs needed for the day-to-day maintenance and administration of a small business. Examples of ongoing expenses are-
- Rent Continuous rental payments at a chosen office location
- Payroll The costs incurred by tracking employees' hours worked and paying them according to a pay schedule
- Business Taxes The federal, state, and local tax obligations necessary for a company to stay in good standing
- Legal Services Drafting any legal documents or business contracts necessary to maintain a business
- Loan Payments The interest payment or other payment amounts from banks or investors to reduce the loan's principal balance
- Business Insurance Payments The price a company pays to an insurer for the cost of property damage, lawsuits, lost income, or other covered losses
- Utilities Electricity, gas, water, phone, and internet services utilized in a business
- Marketing Costs The costs incurred for advertising, promotion, and public relations
Startup assets are also included in business financing. They refer to common long-term items that a company needs to invest in, in order to operate. Examples include-
- Starting Inventory The dollar value of all inventory held by a company, including the goods that can be put towards generating revenue
- Computers and Technical Equipment Computers, headsets, servers, software, or any other technical equipment needed to run a business
- Office Equipment Any equipment utilized for recordkeeping, bookkeeping, cleaning, storage, or other essential purposes
- Office Furniture Necessary furniture for various office locations
- Company Vehicles Vehicles that the company leases or owns for employee use
Cash Requirements to Start a Business
Cash requirements are an estimate of how much money is needed to launch a business. The cash balance includes the money raised from investments and loans deducted by the amount spent on expenses and assets.
Businesses should monitor their cash flow projection, or the amount of money that is expected to come in and out. The company will need to increase its financing or reduce expenses if the cash balance drops below zero because there will not be enough money to cover startup costs.
How Much Cash is Needed to Start a Business?
It's recommended that businesses compile six months to a year's worth of cash to cover startup expenses.
Because this isn't always practical, it's better to calculate the deficit spending the company will likely incur during the first few months that the business is open. Then, estimate the minimum amount of cash needed to move forward until the company can break-even.
Two Valuation Methods to Plan for Startup Costs
There are two ways to estimate and plan for startup expenses. The traditional method involves utilizing worksheets for starting costs and financing. The second utilizes software to automatically estimate expenses, assets, and financing.
1. The Startup Worksheet Method
Businesses can utilize a worksheet to organize the various startup costs. Typically, the worksheet is structured in a specific format-
- The startup expenses are placed in the upper left-hand corner.
- The startup assets are listed underneath the expenses in the lower-left corner.
- The startup funding is positioned to the right side of the expenses and assets.
Remember that this worksheet is about expenses incurred before the business opens and doesn't include ongoing sales, expenses, assets, or financing after the business launches.
Any expenses incurred before the startup launches (listed in the top left corner) are eligible for deduction against income later, for tax purposes. Having costs to deduct from future taxes will reduce the company's overall tax bill, so it's a good idea to keep track of these on the worksheet, as well.
2. Utilizing a Software System
Businesses can also utilize a software system to help calculate startup costs. Users can input the revenues, costs, expenses, assets, loans, and investments, and the software can automatically calculate the total amount of startup costs. It can estimate how much financing is necessary to cover the cost of expenses, helping businesses know how much money to ask for from investors.
Most software systems utilize helpful visualizations to show expenses incurred by the month. Businesses can use these graphs and charts to understand current financials, as well as predict for future months. Unlike the startup worksheet method, most software systems also automatically calculate how much money the business needs to make to cover each month's incurred costs.
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