What to Consider When Estimating Startup Costs

The purpose of developing a business plan as the first step in starting a business is to answer the fundamental, and critical question of how much money the venture will need to be able to begin. It has been my experience that two of my close friends, with different businesses, started out strong but ended up failing due to lack of resources after running out of resources at different times.

A bigger loan, as it happened in the first case, may have enabled my friend to get additional funding had he planned better and applied for a larger loan. However, when things turned bad, his credit suffered, making it impossible for him to get a better loan. My second friend probably would have planned to use fewer resources if she had a more detailed estimate of how much it would cost to start a business, and she probably wouldn't have ramped up so rapidly.

                           

As a small business owner, you have to be aware that having a good understanding of startup costs is much better than having no idea at all and having to face a lot of unforeseen surprises. It's crucial to look at your business expenses as individual components, rather than lumping them together.

Using a few educated guesses and three simple lists, you can essentially calculate starting costs by making three lists as well as adding them all up at the end.

Keep track of your assets to know how much you can spend on them. In the end, your business assets are what you will need in the long run. For example, if you plan to open your own brick-and-mortar store, you'll need items like shelves, tables, cash registers, and so on. A graphic artist may also require specialized equipment in addition to printers and drafting boards.

You should be aware of how much inventory you're going to need in order to start a business, whether you're making or selling goods. For instance, a bookstore needs books in order to stock its shelves, while a manufacturer might need raw materials to begin manufacturing. You do not need to worry about inventory if you're starting a service business - that is, you don't make or sell products. You can skip this step if you're starting a service business.

We would like to take this opportunity to point out that all of these items make up your starting assets. While you may think the money you have in your bank is part of this list, we are going to keep that for another list later on.

It would be wise to estimate the cost of each item on this list based on your research. For instance, you should contact a real estate agent to inquire about rental space and prices. If you cannot estimate the price off the top of your head, do some research. You can also inquire about insurance plans and prices by contacting an insurance broker.

In addition to spending on assets, you also spend money on expenses. For example, setting up a legal corporation, an LLC or a partnership can cost a lot of money, so be sure to list those expenses as well. Additionally, you can also include expenses like the amount of money you spend on your website, the expenses that you spend on your office, and the salaries you pay your employees to help you set up your business.

I would also suggest including expenses for computers and other office equipment on this list because of the special tax treatment I mentioned earlier.

It is now time to add up your starting assets and your starting expenses so that you can determine the majority of your start-up costs.

You will need to calculate how much funding you will need to get started. The final piece of the puzzle is to determine how much cash you will need in the bank in the early months of your startup when you are generating sales but not enough to cover your costs and expenses.

Depending on who you ask, there are a variety of theories on how to do this. Some say you need to save enough to cover six months of expenses, and others say it should be enough to cover a year. But from my experience, it's usually not that easy.

In order to create a sales forecast, I recommend that you estimate your first 12 months' sales, your costs associated with those sales, and your expenses. My previous column can help you get an idea of how to do this. In addition, you might want to consider reading my book Plan-As-You-Go Business Plan's section on creating an expense budget.

It should be possible to come up with a list of 12 months that has estimated sales, costs, and expenses for each month. You should be able to determine if you are short of cash by subtracting the costs and expenses from the sales for each month. This spreadsheet will help you tell how long it will take for you to break even and how much money you're missing. So that's basically what you need to have as a starting capital.

You are already well on your way to being able to put together a business plan after putting together the numbers here, even if you were a little hesitant about putting one together.