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Start It Up

How do you project your start-up costs?

Nikki Roser

By Nikki Roser

Nikki Roser is the President of First Bank. She runs and oversees all aspect of the company’s day-to-day operations, is a CPA and holds an MBA. She’s passionate about building relationships with entrepreneurs and business owners in Southeastern Illinois and Southwestern Indiana and leverages her experience to share financial and strategic advice. Partnering with clients and watching their business thrive and prosper is her greatest joy.

The excitement of launching a new business is a high point in the path of every entrepreneur. However, that excitement is often accompanied by anxiety over financial worries. Once you’re satisfied that the market is large enough to support your new business and that of your competitors, and you feel confident about your ability to win over consumers, it’s time to figure out your start-up costs to determine the affordability of your new venture.

In the excitement of launching a business, many entrepreneurs underestimate how much it will cost to start, not to mention how much cash you’ll need to keep the business going until you reach the break-even point.

Don’t make this fatal error. When you take the time to analyze your financial situation and project your start-up costs at this stage of your business plan, you’ll know how much working capital you need to get started and survive until you turn a profit. Another prudent step is to analyze the rate of return you’ll receive on your personal investment in your business.

New entrepreneurs often use their personal savings or mortgage their homes to obtain start-up funding. Ask yourself these questions before you take out a personal loan to start your company:

  • Do you know all the costs necessary to set up the business? This includes organizational costs, equipment to be purchased, inventory and supplies needed, and the hidden costs that most people don’t consider but can easily add up.
  • Do you have an idea of how long it will take for your business to become profitable and support itself?
  • How many months or years can you survive without making a profit? Remember that you won’t just need cash to support your business during the start-up phase. You’ll also need to meet your personal household expenses.
  • Consider not just the value of personal assets you contribute to your new business, but also the value of your time. As hard as it may be to conclude, you may get a better return on those investments by putting your money somewhere else, such as an investment fund, and taking a job in an established company.

Calculating your initial start-up costs

It’s impossible to know exactly what it will cost to get a business up and running. However, you can establish a reasonable estimate of the costs. Try to be as accurate as possible in your predictions so you don’t underestimate. A realistic forecast of your start-up costs will give you the confidence and peace of mind that comes with being able to meet your business expenses. Your forecast will also help you create a timeline for important milestones like reaching the break-even point.

While you may already have a list of start-up costs in mind, it will help to write them down or type them into a spreadsheet. Seeing your figures in black and white and doing the math will help you make important distinctions between essential costs and merely desirable ones that can wait.

Oftentimes, you will be able to research costs to get close to an exact estimate. Make sure to leave a cushion in your budget anyway, as some expenses will inevitably be more than you expected.

Organizational expenses

Your organizational cost encompasses all the expenses required to get the business legally organized. This generally requires the assistance of professionals and is an area where costs are frequently under-estimated.

Organizational Costs may include:

  1. Attorney fees – Attorneys will be required to incorporate the business, fill patents, copyrights, and trademarks. If you have partners or other shareholders in your business, you may also need buy-sell agreements and non-compete agreements.
  2. Accountants – Accountants will be required to apply for tax identification numbers, payroll tax numbers, and set up accounting systems. Accounting systems may include general ledger, accounts receivable and billing systems, timekeeping and payroll systems, and accounts payable and disbursements systems.
  3. Financial advisory fees – If you are going to seek outside investors to help fund your business, you will frequently need the assistance of outside advisors to find those investors. If you are putting together a business plan to go to a financial institution for a loan or SBA loan, you will frequently use an advisor to put the package together and sell your proposal.
  4. Marketing advisors –Many small businesses use the assistance of marketing professionals to design their logo, letterhead, business cards, and marketing brochures. Most will also require assistance to set up their initial web site.

Assets required to start your new business

When most entrepreneurs think about startup assets, they think of the machinery and equipment required to get started. But that’s not all--startup assets also include the beginning cash balances and the investment in inventory required to get started.

Capital costs include:

  1. Plant, machinery, and equipment
  2. Office furniture and equipment like computers, printers, and copy machines
  3. Vehicles
  4. Computer software

While most startup companies do a reasonably good job of projecting the capital costs, they often under-estimate the costs associated with acquiring equipment and getting everything operational.

Cost that are often missed include:

  1. The freight cost of getting machinery and equipment to your location.
  2. Costs associated with setting up the equipment or electrical modifications to get the equipment operational.
  3. Appraisal and closing costs if the plant and buildings are being purchased.
  4. Equipment appraisal costs if the equipment is being financed.

Try to be resourceful when acquiring startup assets. For example, do you have to buy a new or top-of-the-line item or could you buy second-hand equipment instead? If the equipment won’t be used frequently, consider leasing it to save upfront costs.

Start-up expenses

Startup expenses include both one-time expenses to get the company started and those expenses that are required to be covered before your new business becomes profitable.

Startup expenses often include:

  1. The cost of insuring these items normally requires a full year paid up front.
  2. Utility deposits and connection charges
  3. If facilities are being rented rather than purchased, a security deposit and the last month’s rent are often required up front.

Working capital coverage

Working capital is defined as the amount of cash you need to keep the lights on until you break even. Raising your setup costs is the first challenge, but for your business to survive its first year you must also have enough working capital to cover ongoing expenses until you have sufficient business to generate a profit.

When you’re coming up with your working capital estimate, be sure to include both fixed and variable costs.

Prepare a cash-flow forecast to make sure you don’t run out of working capital

What if you could view next year’s business account statements today? This is what a cash flow forecast tries to achieve. The more accurate you can be in predicting your future bank statements, the stronger your financial management of your company will be.

As the name implies, a cash-flow forecast predicts how much money will flow into and out of your company. Ideally, your monthly income will be greater than your monthly overhead costs and accounts payable obligations.

Don’t fret if you spot a potential cash-flow shortage. This is common among start-ups and identifying cash crunches is a primary reason for doing the forecast. When you see it coming, you can meet with your business banker to discuss loan or credit line options.

Since you don’t have a cash flow history yet, you’ll have to estimate future sales with market research. It’s easier to identify costs because you can get a quote from suppliers.

Your cash-flow forecast should cover the first year of your business. Try to create three different estimates:

  • Pessimistic: Force yourself to imagine just how bad it could be.
  • Realistic: Slightly better, but still grounded.
  • Optimistic: If everything goes perfectly.

If you go ahead with your business plan, you’ll be able to update your forecast with real numbers from your first year in operation. Then you can use those figures for future cash-flow forecasts.

Identify your cash cycle

Every business has its own unique cash cycle. Simply put, this is the time it takes for your product or service to become a paid sale.

For example, a retailer usually receives money from customers immediately (people don’t usually buy a pair of shoes and arrange to pay the shoe store later). Conversely, it could take an electrician a month to finish a job and six weeks to see payment.

How long is your business cash cycle?

Whether you collect payment right away or sell on credit, make sure to factor your cash cycle into your cash-flow forecast.

This is especially important for seasonal businesses, such as a summer lawn service or a retail store whose sales peak during winter holidays.

Be sure to make provisions for ongoing expenses, staff, equipment, and other assets you’ll need to grow your business. You also need to figure out how often you’ll pay yourself a salary from the profits.

Take the next step!

Now that you have a complete grasp of your start-up costs, cash-flow forecast, and cash cycle, it’s time to move on to the details of preparing a cash flow statement and determining if your business is profitable enough to be feasible. Read the next article in our series: “How do you forecast sales for your start-up business?

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