What will it cost to start your business? It’s hard to know for sure. According to a recent survey of nearly 500 small businesses and startups, owners spent $40,000 on average in their first year of business. Regardless of how much you plan to spend, it’s important that you start planning early on to avoid any unforeseen expenses.
Typical startup costs can vary depending on whether you’re operating a brick-and-mortar store, online store, or service operation. But a common theme is that launching a successful business requires preparation. And while you may not know exactly what those expenses will be, you can and should begin researching and estimating what it will cost to start your business.
How to determine your startup costs
Like when developing your business plan, or forecasting your initial sales, it’s a mixture of market research, testing, and informed guessing. Looking at your competitors and industry benchmarks is a good starting point. Once you feel your initial estimates are in the ballpark, you can start to get more specific by making these three simple lists.
1. Startup expenses
These are expenses or upfront costs that happen before you launch and start bringing in any revenue, such as permit and licensing fees, website design, down payments and equipment purchases. As mentioned earlier, these should be split into one-time and ongoing expenses.
By having them outlined this way from the start, you’ll be able to keep better track of your expenses and identify any natural cost-cutting options over time.
2. Startup assets
These are costs associated with long-term assets purchased in order to start your business. While cash in the bank is the most basic startup asset (and we’ll talk more about that later) there are some other common assets you may need to invest in:
- Starting inventory
- Computers or other tech equipment
- Office equipment
- Office furniture
Why separate assets and expenses?
There’s a reason that you should separate costs into assets and expenses. Expenses are deductible against income, so they reduce taxable income. Assets, on the other hand, are not deductible against income.
By initially separating the two, you potentially save yourself money on taxes. Additionally, by accurately accounting for expenses, you can avoid overstating your assets on the balance sheet. While typically having more assets is a better look, having assets that are useless or unfounded only bloats your books and potentially makes them inaccurate.
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Listing these out separately is good practice when starting a business and leads into the final piece to consider when determining startup costs.
3. Cash required to get started
Cash requirements are an estimate of how much money your startup company needs to have in its checking account when it starts. In general, your cash balance on the starting date is the money you raised as investments or loans minus the cash you spend on expenses and assets.
This is the last piece of the puzzle you’ll need to get started. As you build your plan, watch your cash flow projections. If your cash balance drops below zero then you need to increase your financing or reduce expenses.
How much startup cash do you need?
Many entrepreneurs decide they want to raise more cash than they need so they’ll have money left over for contingencies. While that makes good sense when you can do it, it is difficult to explain that to investors. Outside investors don’t want to give you more money than you need, because it’s their money.
You may see experts who recommend having anywhere from six months to a year’s worth of expenses covered, with your starting cash. That’s nice in concept and would be great for peace of mind, but it’s rarely practical. And it interferes with your estimates and dilutes their value.
For a better estimate of what you really need in your starting cash balance, you calculate the deficit spending you’ll likely incur during the early months of the business. From there, estimate how much cash you’ll need moving forward until you hit a steady break-even point several months and even years after opening.
Other considerations for estimating startup costs
Pre-launch versus normal operations
With our definition of starting costs, the launch date is the defining point. Rent and payroll expenses before launch are considered startup expenses. The same expenses after launch are considered operating or ongoing expenses. And many companies also incur some payroll expenses before launch — because they need to hire people to train before launch, develop their website, stock shelves, and so forth.
The same defining point affects assets as well. For example, amounts in inventory purchased before launch and available at launch are included in starting assets. Inventory purchased after launch will affect cash flow, and the balance sheet; but isn’t considered part of the starting costs.
So, be sure to accurately define the cutoff for startup costs and ongoing expenses. Again, by outlining everything within specific categories, this transition should be simple and easy to keep track of.
Your launch month will likely be the start of your business’s fiscal year
The establishment of a standard fiscal year plays a role in your analysis. U.S. tax code allows most businesses to manage taxes based on a fiscal year, which can be any series of 12 months, not necessarily January through December.
It can be convenient to establish the fiscal year as starting the same month that the business launches. In this case, the startup costs and startup funding match the fiscal year—and they happen in the time before the launch and beginning of the first operational fiscal year. The pre-launch transactions are reported as a separate tax year, even if they occur in just a few months, or even one month. So the last month of the pre-launch period is also the last month of the fiscal year.
Consider startup financing as part of your startup costs
Of course, startup financing isn’t technically part of the starting costs estimate. But in the real world, to get started, you need to estimate the starting costs and determine what startup financing will be necessary to cover them. The type of financing you pursue may alter your startup or ongoing costs in a given period, so it’s important to consider this upfront.
Here are common financing options to consider:
- Investment: What you or someone else puts into the company. It ends up as paid-in capital in the balance sheet. This is the classic concept of business investment, taking ownership in a company, risking money in the hope of gaining money later.
- Accounts payable: Debts that are outstanding or need to be paid after a certain time according to your balance sheet. Generally, this means credit-card debt. This number becomes the starting balance of your balance sheet.
- Current borrowing: Standard debt, borrowing from banks, Small Business Administration, or other current borrowing.
- Other current liabilities: Additional liabilities that don’t have interest charges. This is where you put loans from founders, family members, or friends. We aren’t recommending interest-free loans for financing, by the way, but when they happen, this is where they go.
- Long-term liabilities: Long-term debt or long-term loans.
Aim for long-term success by estimating startup costs
Whether you use the LivePlan method or the traditional method for estimating your startup costs, make sure you’ve considered every aspect of your business and included related costs. You’ll have a better chance at securing loans, attracting investors, estimating profits, and understanding the cash runway of your business.
The more accurately you layout startup costs and make adjustments as you incur them, the more accurate vision you’ll have for the immediate future of your business.