How To Estimate The Cost Of Starting A New Business From Scratch: A Guide

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How To Estimate The Cost Of Starting A New Business From Scratch

The desire to start your own business, make your own money, set your hours and even have the joy of knowing you built your own life on your terms is an aspiration shared by most people. Many well-intentioned people start out making their dreams come true only to be disappointed by the entire venture. In short, it failed.

Why And What

Now in all of life, we never consider anything a failure if you learn from it. It is only for you to know the “why” you want to start a business and what product or service you will provide.

One of the best lessons an entrepreneur needs to learn is the financial cost of starting a new business from scratch. We want to give you the basics of estimating the cost of starting a new business.

What Is Your Business Model

For the most part, businesses can be categorized into three separate business models.  All three will need to have an online presence in the form of a robust and even interactive website presence. The three types fall under the following general types:

  • Brick and Mortar
  • Online
  • Service

The Brick and Mortar will be most retail businesses that provide products that are physical and add value to our lives. This is everything from grocery stores, car dealerships, bank branches, shopping malls, and the list goes on. The deciding factor will be that you need a building that customers can walk into and obtain the product.

An online business can be described as any business that provides products provided to customers completely through and access via the internet. This would be like information services, membership sites, education sites, and digital email marketing just to name a few categories.

A service business can be described as trades such as plumbers, electricians, and construction. It can also be described as consultant professionals such as financial advisors, lawyers or any other consultant to address human needs.

In the technological advance, we have now; many businesses will be a combination of the three distinct models. This is important to know as you work on estimating the cost of new business from scratch.

General Startup Costs

When we discuss startup costs we are considering at least a 3 to a 6-month projection on the after startup operating costs. The reason is that most businesses fail within 5 years and you will need the financial resources to weather the storm of being a new business.

Maybe some of these startup costs will not be needed at first, but many wills and do not eliminate any of them, but plan for them. Here is a startup list:

  • Office or Home space
  • Equipment and supplies (computers, printers and ancillary)
  • Utilities
  • License and permits (are you legally operating)
  • Insurance (Liability, workers compensation, health insurance)
  • Communications (Cellphones, Office Phones)
  • Legal (Attorneys, accountants)
  • Inventory (Where is your product located before sale, also raw material inventory)
  • Employee Salary (this could be just you if you are solo, but could increase with additional help)
  • Advertising and Marketing (remember even well-known companies still advertise)
  • Printed Marketing Material as needed includes business cards
  • Website costs
  • Transportation costs

This is just the basic list. There may be more depending on your business model and the type of business you desire to pursue. In this estimation, you will need to understand that there are one-time startup costs, on-going costs, fixed costs, and variable costs.

A one-time cost could be the purchase of office equipment or vehicle that is durable for at least 5 years. On-going costs are monthly costs such as utilities, salary costs and so forth.

Fixed costs are those that have a constant value month over month as such the monthly cost of an office. Variable costs are costs that can change from month to month. One example might be office supplies or even labor costs that can change based on the growth or stagnation of the business.

There are potentially more startup costs to getting any business up and running; those listed here are just a start. Each type of business has its own set of startup costs.

Many templates will help you with this. You just download the template, plug in the numbers and it will tell you your startup costs.

There Are No Hard And Set Rules

You should understand that startup costs for any business are not an exact science. Accountants and professional business analysts can all honestly disagree. We, therefore, have to go with the definition that startup costs are those expenses and assets required to get a business up and running.

  • Startup Expenses are all the expenses needed to bring in revenue and typically occur before you start your business
  • Startup assets are durable goods (computer, vehicles, furniture, etc.) Cash in the bank, inventory if needed.

So opening a small factory with even 5 employees will cost more than opening an online business as a content writer or professional consulting business. You need to know the business you are entering and know it well enough to estimate these costs.

Cash Balance Equals Solvency

The cash balance is the estimate of how much money you will need to startup your business on the day it officially opens.  It will include all the money sources you have used to acquire the cash assets needed minus the money you spent to manage to get your business up and running.

The formula is quite simple:

  • Money earmarked for business – all startup expenses = Cash Balance

Now the Money earmarked for business may have come from one or a combination of the following sources:

  • Self-funded (Bootstrap funding-the risk is all on you)
  • Investors (They are accepting the risk with you as partners but expecting an ROI)
  • Loans (They are expecting to be paid back with an ROI at no risk to themselves)

The cash balance is important in that it will be used to take care of the operating expenses after the initial startup date. One could argue that have 12 months of cash balance in the bank is a good idea, but is that attainable for most people?

Even a small business that has operating expenses of $10,000 per month would need about $120,000 in their cash balance to cover a year or any short term unexpected contingencies. This would be nice to have, but a more realistic approach might be maybe three to six months operating costs.

In this case that would be $30,000 to $60,000 of cash balance needed. This amount could be reasonable and realistic assuming that income from the business could start coming in by the second or third month.

Please note, this was only an example!  We are saying that each business is different and will need three to maybe six months of cash balance based on the monthly operating expenses.

  • Cash balances should = monthly operate expenses x 3 months.
  • Cash balance should = monthly operating expense x 6 months for high upfront cost type of business.

The larger the business venture in terms of startup costs, inventory and monthly operating costs will require a longer time frame to stay solvent. This will be especially true if you hire employees.

No one will want to work for you if you cannot pay them over a reasonable time. What would happen if you had enough money to start a business and hire a few employees, but could not pay them in month number 3 due to low cash balance?

You could set yourself up for a lawsuit doing that. So basically the higher your cash balance and the lower your operating costs are the better strategic plan.

Cash Balance is what can keep you sleeping soundly at night or keep you up at night.

Accounting And Tax Law

As soon as you get your business up and running, especially with employees and physical assets, it may be time for you to quit doing your taxes. A well-paid tax accountant can certainly be worth every dollar paid them.

Part of the reason is distinguishing between expenses and assets. Expenses are deductible against your income and assets are not deductible against income.

That sounds simple enough, but how does one determine for sure if something is a legitimate business expense or a business asset?

Buying inventory is a cost to acquire an asset and does not change the net worth of your company. Selling the asset is the cost of goods sold and reduces income.

So is money spent on research and development an expense or an asset? Is this an asset now because it is intellectual property?

The many ways you can get into trouble with US Tax Law exponentially go up once you have a business. You want to maximize deductions against income as expenses to reduce your net taxable income. So determining what a legitimate expense versus an asset can be quite tricky at times.

Do not skimp on finding a high-quality tax accountant and tax preparer for your business.

Business Type

Also, is your business?

  • a sole-proprietor
  • Limited Liability Corporation with a single owner or multiple owners
  • Limited Partnership
  • C-Corporation
  • S-Corporation?

All of these types of business structures have their own rules in the US IRS Tax code and figuring them out can become quite a burden.

For example, some of the entities listed above will require you to figure out the business tax before your income tax each year. The reason for that is they are considered pass-through entities and this makes it impossible to finish your taxes until you finish the business taxes.

Do You Have What It Takes?

In this extremely short guide, we have given you some of the concepts as to the startup costs for a new business launch. It was meant to be general and not an exhaustive, answer all your questions discussion.

We suggest that you explore the Small Business Administration (sba.com) to get a firm grasp on what it takes to get started in the business. There are other resources such as the National Federation of Independent Businesses (nfib.com) and many legal firms that will help you get started in the right direction. Do your homework.

We have briefly discussed how to determine your initial costs, what are startup assets versus startup expenses.  You had to think about the type of business as retail, online or service or a combination.

We even discussed some of the ideas around the necessity for a cash balance after startup to keep your business solvent.

There are always issues concerning tax law, Federal, State, and Local laws. We even discussed what it means to decide the importance of your business entity setup.

So when it comes to starting your business and how to estimate the cost including the operating cost maybe at least we have opened your understanding to a few of the concepts.

However, the reals cost lies more in what you want to do with your life and less about the financial costs.

Even if you had all the capital needed to start your business and could fund it for let’s say the next two years before you made your first positive profit margin, have you answered the two most important questions.

  • Why do you want to start this business
  • What do you want to provide to others to help solve their problems

Your why has to be extremely big. It has to go down deep into your mind and subconscious and only you can answer this question. If your why is not very big, not clear to you then the chances are high that this new startup will not succeed.

If your motivation as to what it is that you are providing does not have behind it a big strong desire to help others through the free enterprise capitalism, then it may very well not succeed.

All we are saying here is that the startup costs are partly financial and partly about your life. You have only one life to live so you need to make sure that your passions in starting a new business far exceed your comfort zone of staying where you are.

So take the time to know yourself, your finances and your resources so you know the true cost of estimating the cost of a startup business.