Calculate Your Startup Costs
Determining How Much Capital Your New Business Needs
‘The last 10% it takes to launch takes as much energy as the first 90%.’ - Rob Kalin, founder of Etsy
As a serial entrepreneur involved in the startup process of multiple concepts, I understand what Mr. Kalin is talking about. Many ambitious men and women have ideas for a business of their own, and the vast majority of these would-be founders give up somewhere along the way, generally when they are just around the bend from a successful startup.
The largest mitigating factor in this make-or-break process is capital. People stop short of their goals because they either can’t raise the necessary funds to continue or (more often) they perceive that they’re out of financial options. Let’s take a disciplined step-by-step look at how to forecast your own financial needs so that you can adequately prepare to see your brainchild through to fruition.
Understand the Types of Costs
Before you begin to calculate how much capital it will take to get your business off the ground, it is necessary to understand all of the areas where you will incur costs. In the broadest strokes, new business costs break down into expenses vs. capital expenditures.
Expenses are the financial demands that have an indirect translation to your final product. They are the incidental costs, not the raw materials. Examples of expenses include research, advertising, and consulting fees, including legal and accounting.
One Time vs. Recurring
It is possible to break down expenses many ways. One of the most essential is to understand which costs will only impact your budget once and which you need to account for monthly, quarterly, or annually.
Essential vs. Optional
Another important way to divide your expenses is into those that are necessary and those which are nice, when the budget allows. By doing so, you’ll already have noted which spending needs to be put on hold when the budget gets too tight.
Fixed vs. Variable
Some costs (e.g. rent) are largely fixed while others (e.g. labor, cost of goods) vary depending on your level of business. This is a huge factor when determining your break-even point: the minimum level of revenue your business needs to be profitable.
The other main category of costs is capital expenditures. These are generally physical products that are either part of your inventory or necessary for the production and transport of that inventory. These non-inventory assets can include real estate, machinery, and vehicles. One major point to note about the difference between expense and assets purchased as part of your capital expenditure: this 2nd group have a value regardless of the success of your business. They can be resold.
Tax Deduction and Depreciation
Because small business is an important driver of the local, regional, and national economy, the government engineers tax code to benefit the entrepreneur. Generally, expenses related to opening a new business are tax-deductible, either in the first year or amitorized over the first few years of operation. While capital expenditures cannot be deducted, they can sometimes be written off your taxes through the process of depreciation. It’s important to consult tax code and employ the expertise of an accountant or other professional financial help.
Project Your Costs
Now that you’ve thoroughly vetted all the potential sources of expense between you and opening your small business, it’s time to calculate your total cost.
Investigate Similar Successes
According to the US Small Business Administration, most small businesses get off the ground for less than $5,000. This surprisingly low start-up cost is due to two very successful small business models: the home-based sole proprietorship and the home-based franchise. The key to both of these is to limit startup costs by initially working out of your home. As a large percentage of businesses move away from physical locations and inventories, this is an increasingly viable option for many entrepreneurs.
Many serial entrepreneurs endure one or multiple failures before enjoying their first success. It’s important not to expend a potentially crippling amount of resources before you have verified that there is a market for your new product or service. Test market your new enterprise in a controlled setting and don’t be afraid to move on if there is little interest.
Know Your Break-Even Point
Every business has a break-even point. This is the bare minimum of revenue needed to begin turning a profit. Generally, the higher your fixed costs, the higher your break-even point. If you are able to operate your business from home with a minimum of expenses, your break-even point may be very low. This is optimum for the ‘small start’ method I recommend to first-time entrepreneurs.
Assess Your Assets
An important step in the process of calculating how much capital you’ll need to open your new startup is to assess your current assets. This means to take a realistic look at how much capital you already have and how much you’ll be able to obtain through other sources.
They say, ‘you have to spend money to make money’. Another way to look at this is that the more money you have to invest, the larger margin of error you have when opening a new business. Make an honest assessment of your personal finances. How much investment risk can you take?
Most people don’t completely self-fund their own start-up business. Depending on the type of business that you have and your resume, reputation, and level of experience, there are many other funding sources open to you. Do your due diligence to assess the risks and rewards of pursuing external funding sources for your startup. The accumulation of this capital may open up many additional business development options.
Do the Calculation
Once you’ve gathered all the necessary information, do the math. There are myriad resources available to help you calculate the total amount of capital you need to get your small business open. Make an honest comparison of cost projection to your current resources and sales forecast. If the numbers don’t work in your favor, don’t be afraid to walk away and consider other possibilities. Don’t force a bad position. The financial repercussions are too great.
The Bottom Line
There is nothing I love more than opening new businesses and helping other adventurous entrepreneurs enjoy the same success. Predicting the level of financial investment needed to open a new business is never the exciting part of the process. It’s tedious, frustrating, and can be downright scary. But, I can’t overemphasize how important it is. Put the work in now, ask questions when you don’t know, and make a solid plan for the success of your small business.