Estimating Realistic Startup Costs
Have you ever had an interesting idea and thought that it might be turned into a successful business?
Well, you probably have, as has almost everybody.
Where are those businesses and why there are not more successful businessmen and businesswomen in the world?
The thing is, very few of those initial ideas go from a fleeting thought into an actual realization, and even less become successful in the long run (statistics say that, due to various reasons, around 50 % of startup businesses fail during the first year of existing).
The reason behind why people are not more prone to taking action and bringing life to their ideas is the fact that embarking in business could seem like a long shot- a risky, possibly irresponsible undertaking that can leave you with nothing, or at least, with less than you have initially had.
So, finances are the main reason why so many good ideas have never seen the light of the day, and it is really easy to see why.
Even if you talk to the successful businessmen and ask them about their beginnings and how they tackled finances they will remember the time as stressful, full of difficult decisions, anxiety, and anticipation.
The benefits and reaping the success came later. Much later.
So, if you have decided that your idea is worth turning into a business, and if you are ready to take on the responsibility, angst, and excitement of trying to create a name for you in the business world read on.
WHERE TO START
Okay, so you have an idea, but is that enough?
Unfortunately, it is not.
For the idea to be turned into a business it has to be either innovative so there is no competition on the market, or it has to be in high demand or offer a better service than other businesses in the same area.
To know that, you need to do market research of the field that you are interested in.
This will give you a sense of what is out there and you can feel less anxious or scared to delve into the investment.
If you are not going in blind you know where you are putting your money, and if you can take that risk.
The next thing you should do is make a business plan.
Answer the questions like what you consider needs to be achieved in order to consider yourself successful, where you want to be in five years’ time, how you want to get there, and so on.
Set up milestones like ”In one year my store should earn this much.” or “In five years the company should be international.”
When you set up those goals, you come to the most important part and that is: How do you get where you want to be?
This is where finances come into the picture- your actual plan of allocating resources and earning money.
Pay attention that your plan is not something that you follow blindly.
The plan should just be an outline, something to help you shape your idea into action.
On the way, you will probably have to diverge from the plan, as you will notice that you had a wrong perception of how thing work or you might realize that you need more time to reach that milestone, or it is harder than you thought.
This is where you should persevere.
Blindly sticking to the plan may be one of the causes that high percentage of startup failures.
WHAT ARE YOUR NEEDS?
So, we are finally ready to start talking about money.
How much money will you need to get your business up and running?
It is important to know that this depends on the type of business itself: the startup costs for, let’s say, an online shop will not be nearly as big as those for a restaurant.
Now, let’s imagine that you are a first-time businessman and you have no idea how much money you need to open a restaurant.
How much are the furnaces and the stoves, the furniture? What about chefs’ paycheck?
The first thing you should do to get closer to calculating your costs is to, once again, do the market research. This time focus on finding the public financial statements of similar businesses, talk with people in the industry, and get advice.
Which brings us to the next thing and that is having a person in your team who knows what they are doing. Do you know the actual realistic costs of the things you need? If not, seek advice from a mentor.
It can be your cofounder, an accountant, a friend or a family member just as long as that person has experience in owning a business and preferably a successful one and is willing to mentor you.
If you do this alone, chances are you are going to miss something in the learning process, and that can make a difference in terms of success or failure.
Take out as much guessing as possible from the process (this is impossible for innovative ideas in which case you only have to guess as there are no previous data to draw from).
A crucial thing is to think six months to a year ahead when you are calculating how much money you will need.
A year is optimally a timeframe where you can see if your business is on a growth path, so make sure you do not experience a financial setback during that time.
To avoid that you will have to learn how to preserve cash. How do you do that?
Start with the essentials.
This means that you get everything that you need rather than what you want.
To get your restaurant up and running you would need a stove and a fridge, but will you need a pasta roller right away if you are not planning on making your own pasta for a couple more years? No.
And just like that, you saved yourself a couple of hundred dollars.
If you eliminate other non-essential items using the same thinking pattern, you will lower your cost by a sum that makes a difference.
Negotiate terms from vendors or get a lease on the items you need rather than buying them. It will lower your initial cost requirements.
Another smart thing to do is getting several bids (at least 2 or 3) for the same item you need. Pick the most affordable option but pay attention not to disregard the quality.
Your costs are divided into two groups based on how many times you would need to pay for them. The first group is fixed costs, and the second group is the recurrent costs.
The fixed costs include:
- Furniture and supplies (computers, microwave, phones, AC, and more) – you only get this once, or at least, you are not expected to redecorate or purchase computers very often
- Branding – this is something you do before you set up a place, and if you do it right; you do it just this once.
- Logo – Create a logo yourself or pay a designer to do that for you, chances are, once your mind is fixed on the idea, it will not change. This expense entails setting up a banner or a screen with the logo on a suitable place.
- Advertising material – posters, flyers, business cards, pens and more. If you order enough in the beginning, you will not have to refill the stock later on.
- Permits and licenses – for a lot of industries you need to get a legal license to do the desired work. Cross it off your list, and do not worry about it anymore.
- Legal fees – there is a certain amount of money that you need to pay to be able to run a business. The amount differs from state to state so visit your local courthouse and get the required information.
There are other items that can be taken into account depending on the type of business, so this list is not a definite one.
The recurrent costs are those that you will need to cover annually, monthly or weekly and they are:
- Rent – if you need to take up a specific space. This is redundant for home-based or online businesses.
- Electricity, phone bills, internet connection
- Supplies such as paper, pens, staplers, pins, and so on.
- Advertising – pay for ads on local radio or TV stations, newspaper and more (Less than 10% of your budget).
- Inventory or raw material – If, for example, you are selling hats, you need to invest in and refill the stock of hats available in order not to run out. If that happens it creates a bad image of the company. Get raw materials if you are for example specializing in selling hand-made lamps- get enough of everything that you need to make the desired number (up to 25% of your budget).
- Payroll – This entails that you would need to set aside the money that needs to be allocated to issuing paychecks to all the employees. Set aside enough money to get your own paycheck. (Allocate somewhere from 25% to 50% of your budget.)
- Lease payments
To get a better picture of what you need, make a list and put down anything that comes to mind, even if it is the smallest thing that you consider irrelevant.
Just put everything down.
Once you have made your list add up the costs, then try to go back and lower them by 25% if you can (and even more).
When starting up a new business, novice entrepreneurs are well aware of those fixed costs and it rarely happens that there is an oversight in that area.
They come about early in the process so they cannot be missed. At least not easily.
The oversight often happens with the estimate of how much money is needed for the recurring costs. The money needed for the day-to-day functioning of a company is called operating or working capital.
Why do you need it? Let’s put it simply and with the help of an example.
If you are a farmer and want to grow tomatoes enough to sell them and never purchase them yourself again, you will need pesticides, watering systems, someone to pick them and so on.
This is what you need to keep your tomato farm running. If you want to eat tomatoes while you are waiting for the ones you planted to ripen, you will need to purchase the tomatoes form another farm or vendor.
In order to get the tomatoes, you will need the money to purchase it.
There are three types, or rather three stages of breakeven:
- Breakeven without a consistent salary or withdrawal. This means that the business pays for itself but not yet for you.
- Breakeven with minimal consistent salary or withdrawal. The business starts earning you a certain amount of money. It is not the ideal yet, but the growth shows, and eventually,
- Breakeven with a good salary and withdrawal. You can consider your business a successful one.
Let’s take sales for example. To know when you have achieved the third stage of breakeven, you need to know which revenue you will have to hit and when you expect to hit it.
To calculate that, you should forecast sales revenues, cost of goods (COG), gross profit (GP), monthly overhead expenses (fixed expenses), and net profit. You should make that forecast for 6-12 months.
So, now that you have reached the preferable cost for everything you need to start your business, what is next to consider?
It is the project’s funding.
This entails all the finances put together in order to start your business.
Laymen may think that all initial funding has to come from you if you are creating a business.
How many people would you think would be in a position to do that?
Almost nobody, actually.
There are various sources that can help you get the amount needed.
The first one is definitely you. Do you have some savings waiting to be used for something meaningful? Invest them in a new business.
How much money you have to start with is of no importance if you are being smart about the investment.
Another investor can be your co-founder or your partner. Pull your funds together to see if there is enough to cover at least the first 6 months from the initial date.
If you find that both of you (or more) still do not have enough money, the time has come to bring in a third person into the mix.
Now, what you can do is ask for outside capital in three different places:
Go to the bank and apply for a loan. Many banks offer special deals for startup companies. So just go to your bank and get the information on what requirements you need to meet in order to qualify for a loan.
Another thing that you can do is get funding from so-called angel investors or venture capitalists (VCs). An angel investor is a person who is ready to invest some of their own money to help you out.
They usually have experience in creating startup companies; maybe they have done it successfully in the past and now want to help out other striving entrepreneurs.
Of course, they do not to that out of the kindness of their hearts. When they invest in your startup they get shares of your company that they can later sell and earn money themselves.
The third outside investor can be a venture capitalist. A VC is a person who works for a venture capital companies.
They take other people’s money and invest them in startup companies. In exchange for the investment, they also get their fair share of shares of the company.
The shares are divided among the investors according to the amount of money they have invested. But, how do you get the investors to help you out?
How do you persuade them that your company is not a hopeless case just waiting to fail?
With companies that already exist but need more funding for branching out, there are existing financial statements, evidence of the company’s success and proper functioning, so the investor can deduce that their money will not be put at too much risk.
However, the startup with startup businesses it is more difficult to set up a value of the company. As the business is brand new, there are no previous accounts to rely on.
Then startup valuation comes into the picture. There are several methods that can be used and some of them are Venture Capital Method, Discounted Valuation Method and more.
How do you know that you need more funding?
When you have added up all the items that you would need for the business to run (both one-time and recurrent costs), and when you have added up all the funding sources (personal, angel investors, VCs, and bank loans), it is time for a review.
If your cost is lower than your funding, you are on the right path, and even have some funds to spare. If your cost is higher than your funding you should consider either getting more funds or reducing your cost.
Get an accountant, and get one right away. You might think that your expertise is enough to add up some numbers and see if you have enough funding, and you might be right. But what if you miss something?
Hiring an accountant at the very start could seem like one of those optional costs to take into account.
And yes, allocating a certain amount of money to use as the accountant’s paycheck could seem like a lot when you are on the very beginning and you are not even paying yourself yet. (There is another, cheaper option: hire a part-time accountant or a volunteer to that for you.)
An accountant is extremely valuable. He keeps track of all your expenses, makes sure that you have collected all your receipts, and keeps things organized.
He is likely to save you a lot of money in the long run. Experience has shown that hiring an accountant can be a lot less expensive than if you do it later and try to cover the mess and play catch-up”
Pay attention who you are partnering with.
Make sure that the person who creates a business with you is trustworthy.
Usually, it is someone you know well- a good friend or a family member, so you think you are familiar with their work ethics as well.
In that case, just make sure that they share the same values and passion for the idea.
You do not want to wake up two years into your business only to realize that your cofounder does not want to do it anymore.
And, this one is maybe obvious, but do not jump into partnerships with people you do not know just because their story sounds inspiring.
Allocate “rainy day” money. Since you cannot predict the amount of money to a dime, give yourself space to make mistakes.
The rainy day fund will cover any unexpected expenses or setbacks that you might encounter.
This can be anything from paying a fee to a computer technician if a computer crashes, or covering some bigger issues.
Getting your new business up and running can be stressful for many people. However, if you tackle the matter in the right way-responsibly and thoroughly, there is no need to be afraid of a little math.
Do your research, ask your mentors for advice, track your growth progress and you should be on the right path to owning a successful and thriving business.
However, following a plan and wanting to earn a lot and be rich will only get you so far. To truly be sure of your future success, combine all those before-mentioned factors with pure passion and love for what you are doing.
Only by knowing the true purpose of why you are doing what you are doing will you succeed in establishing yourself among other successful businessmen?
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