How to Estimate the Cost of Starting a Business from Scratch – US
How much will it cost you to start your own business? Obviously, you will never know for sure, however, you could use some reasonable estimations. All you have to do is break them down into simple lists. Then, you can work from these lists. It’s going to be a guessing game, but the good news is you could make a good guess.
Startup costs are the expenses required before you start running your business. Most people take these startup costs too lightly and they start their business in a chaotic way without any plans at all. Although this could work, yet it will be too difficult. One of the significant elements of your financial plan is to make a realistic estimate of your startup costs. Sometimes it is hard to figure out your startup costs if you can’t compute them accurately.
What Are Startup Costs?
People should be aware that startup costs are not accepted globally. It is not even considered as a well-defined financial model. But accountants and analysts don’t agree with this. Startup costs are defined as the expenses you acquire and the assets that are essential before you can start your business.
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Are you planning to put up your own business? If so, do you know how much money you need in starting your own business? There is no doubt that the cost will likely depend on the industry that you choose as well as the type of business that you want. However, based on the study conducted by the Ewing Marion Kauffman Foundation, the average cost of starting your own business is just over $30,000.
But most small businesses, especially online, freelance, or home-based businesses only require a much lesser amount. Most often, they can start with just a few thousand. But regardless of the average cost, can you truly calculate how much you need for your startup cost?
Keep in mind that if you want your business to be a success, you must be well prepared. By calculating the startup costs for your small business, you will know if you need more funding, you can also estimate when you can earn some profit, create a breakeven analysis, know how to save money with tax deductions, most of all, this can help you in attracting investors. Knowing your expenses can help you in launching your business successfully.
How Startup Costs Are Spent?
Before doing any calculation, it is important to know how these startup costs are being classified. When we say startup costs, this is the period wherein you start spending even if you have not started earning any income. The two types of spending are assets and expenses.
Assets are also called capital expenses or expenditures. These are one-time spending that is used for buying equipment, vehicles, properties, and inventories needed in your business. However, they can also be used as payments for security deposits. Although these capital expenses may not be considered as a deduction, yet they can still be written off through depreciation.
Typically, assets include your cash and beginning inventory. When you start your company, you should have some money in the bank. Assets could either be current or long-term. Vehicles, furniture, and equipment are just some examples of long-term assets.
These are the costs needed by your business to make it operational. Usually, this will occur before you start your business and before revenues start coming in. For instance, as a new company, you will have to spend on your logo design, legal requirements, brochures, improvements on your location as well as other expenses.
Although, they are not only needed during the startup stage but all throughout the time that you are operating your business. These expenses are usually deductible items including office supplies, rent, payroll, travel, marketing costs, and others. It can also include startup organizational costs such as state incorporation fees, legal fees, and others. Since they are deductions, then you can write off up to $5,000 for your startup costs and at least $5,000 for your organizational expenses but only during the year that you began operating your business.
Where Would You Spend Your Money?
The best way to assess your startup costs is to start making two lists. One list is for your assets and one list is for your startup expenses. Be sure to include everything in your lists including the inventory needed, equipment, improvements in your facility as well as other aspects in your business. You should also include website development costs if you want to create a website for your company. The cost of making business cards, brochures, and other marketing materials which are needed by your company. Does your company need to make any security deposits? Some businesses require the help of a lawyer, tax advisor, or consultant.
The next thing to do is to identify if these items are important or optional? Is it necessary for you to spend some money on these things even if you have not yet earned any income?
How Much Do These Items Cost?
After having your list of expenses, the next thing to do is to estimate how much they cost. You need to assign a certain amount for each of these items. This process will vary for every expense. Basically, what you can do is to simply make a guess on the cost of each item. Although some of them have well-defined costs, however, for pertinent expenses such as permits and licenses, they must have clear and established costs. But for other costs which are uncertain such as employees’ salaries, you could make an estimate on them.
However, if you want to be more realistic, then you should do some research, use your previous experience or ask some help from other entrepreneurs. You can also consult your local Small Business Development Center. They can provide you some valuable information on how to calculate your startup costs. Don’t worry these organizations will provide them to you for free.
Another option is to use your smartphone. After downloading the SBA Mobile App, you can already start calculating startup costs. Keep in mind that you should not underestimate your costs or change the cost intentionally so that it will be suitable for the money that you have right now. If you think that the costs are too much and you can’t afford it, then you should consider another way of starting your business.
For instance, rather than purchasing your inventory upfront, you could search manufacturers that can drop ship them. Or instead of hiring your own employees, you could choose to subcontract. You could save some money if you just run your business at home. Rather than buying brand new furniture and equipment, you could purchase the surplus ones from the government?
Organize Your Expenses
Adding up all your expenses will give you a complete picture of what your financial needs are. So, after identifying how much your business expenses are, the next thing is to organize them by separating one-time expenses and monthly expenses.
One-time expenses are the primary costs that are required so you can launch your business. This includes buying new equipment, paying for the permits and licenses, paying for your logo design, etc. Essentially, one-time expenses can be deducted from your tax which can help you in saving some money. Be sure to always monitor your expenses and inform your accountant about it before filing your taxes.
Basically, monthly expenses include employees’ salaries, rent, utility bills among others. You can calculate a whole year of your monthly expenses, but ideally its best to make it five years. Add your one-time expenses and monthly expenses so you will know how much money you will need for your capital and when you will need it. Preparing them beforehand can reduce your stress.
This startup cost computation can be used for acquiring your startup funding. Creating a formal report of your projected startup costs would be a good idea. Make sure to present it in such a way that it is much easier to understand. In this way, it will be easier for the lenders and investors to make a comparison between your anticipated costs and expected revenue. This can also help them determine if there is some potential for your business to make some profit.
How Much Cash Balance Do You Need?
When your company starts, it is important that you have some cash on your checking account. Simply make an estimation of how much money you need for your startup company. Generally, your cash balance is the money that you considered as your investment. Or this could be the amount of your loan less the money that you spend on expenses and assets.
As you go along with your business, you must be conscious of your cash flow forecasts. Once your cash balance has dropped, then you either decrease your expenses or increase your financing requirement. Most entrepreneurs would choose to increase their cash so they will have some reserved money for emergencies.
Although it makes perfect sense, yet it is quite difficult to explain this to your investors. External investors would probably refuse to give some money. Well, obviously, because it is their money. Though most experts would probably recommend that you should allocate an amount that is good for your six months or one year. This will become your starting cash. While this is a good idea but sometimes this is not practical. It can create a great impact on your estimations and weakens their value.
If you want to have a better estimation of the cash balance that you need, then you need to compute your deficit spending. These are the expenses that you acquire during the first months of your business. This will start from the day that you launch your business until the time that you’ve reached a monthly break-even stage. During this time, your revenues are now the same as your spending.
For some businesses, it will take months and even years to obtain a stable break-even point starting from the time that they’ve launched their business. And sometimes these pre-launch estimates may not be reliable. Probably, the perfect number for your business would be $30,000 or more. The expenses for your six months operation would be about $240,000. Having this amount on the bank would be nice, but sometimes it is difficult to attain.
The Key Is Timing
Keep in mind that startup costs can accumulate even if you have not earned any income to support your business. This is something that you have to think about when creating your budget. When it comes to starting costs, we can say that the defining point is the launch date. For instance, payroll and rent will only start once your business has started operating. Then, this will become an ongoing expense that you can get from your profits. Most companies will even start incurring payroll expenses even before they have launched their business. This is because they must hire workers who will arrange their stocks on the shelves, people whom they will train before launching their business, developers who will create their website, etc.
It also has the same effects as assets. For instance, the total amount of the inventory that you purchased before you launch your business is also part of your starting assets. Consequently, the inventory that you purchased after you have launched your business can likely affect your cash flow as well as your balance sheet. However, this is not included in your starting costs. Depreciation costs should only start once your business is fully operational.
Assets Vs. Expenses
Most people are confused by the difference between assets and expenses. For instance, they consider research and development as assets rather than expenses. This is because they will establish intellectual property. Nevertheless, taxation law and standard accounting are very meticulous about its difference. Assets cannot be deducted against your income, but expenses can be deducted, hence it can help in minimizing your taxable income.
When your company spends money to obtain assets, this will not be deducted from your income. For instance, the money that you spent on inventory will not be considered as an expense, therefore, it is not deductible. However, once the inventory is sold, then it can be counted as a cost of sales or cost of goods sold, hence, it can reduce your income.