What will it cost to start your business? It’s hard to know for sure. But accurately estimating startup costs is a complicated and necessary process to get your business successfully off the ground.
What are startup costs?
Startup costs are expenses incurred before the business is running.
You should know that startup costs are not a universally accepted or carefully defined financial concept. Accountants and analysts disagree. For planning and management purposes, we define starting costs as expenses you incur and assets you need before you can launch the business.
Why calculate startup costs?
Estimating realistic startup costs is one of the key elements of your financial plan. Understanding what it will take to start your business can help you:
- Secure loans and attract investors
- Estimate profits
- Conduct a breakeven analysis
- Identify potential tax deductions
- Extend the runway of your business
Many people underestimate startup costs and start their business in a haphazard, unplanned way. This can work in the short term, but it is usually much more difficult to maintain. Customers are wary of brand new businesses with makeshift logistics, and managing startup costs is almost impossible until you calculate them accurately.
Every single industry and business requires vastly different expenses, which means there’s no simple formula for calculating startup costs. But that doesn’t mean you can’t make an educated guess that accurately reflects the needs of your business.
Like when developing your business plan, or forecasting your initial sales, it’s a mixture of market research, testing, and informed guessing. It’s up to you to then adjust accordingly based on actual results over time.
Now that may still leave you wondering, how do I estimate realistic startup costs for my business? And the answer is making three simple lists, a few educated guesses, and adding them all up.
These are expenses or upfront costs that happen before you launch and start bringing in any revenue. These can be split into one-time and ongoing expenses, and by separating them in this way you can give yourself a more accurate estimate of what it will take to launch your business. Here are some common expenses to consider in both categories:
- Permits and licenses
- Incorporation fees
- Logo design
- Website design
- Brochure and business card printing
- Down payment on rental property
- Improvements to chosen location
- Legal services
- Loan payments
- Insurance payments
- Marketing costs
These make up just a handful of the potential costs you’ll need to consider. Some will remain fixed and others will operate as variable costs.
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?
Now 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 some 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.
Listing these out separately is good practice when starting a business and leads into the final piece to consider when determining startup costs.
Cash required to get started
Cash requirements is 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 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 hard to explain that to investors. The outside investors don’t want to give you more money than you need, for obvious reasons—it’s their money!
You can find experts who recommend you should have some set amount, such as six months’ or a year’s worth of expenses, as 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 the estimates and dilutes their value.
For a better estimate of what you really need as starting cash balance, you calculate the deficit spending you’ll probably 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.
Two ways to plan for startup costs
Now that you have your potential assets, expenses, and starting cash it’s time to put them all together to estimate your full startup costs.
I’ve worked with two methods for estimating and planning for starting costs.
The more traditional, which I call the worksheet method, involves separate worksheets for starting costs and starting financing.
The more innovative, which we use in our LivePlan software, simplifies this with rolling estimates for expenses, assets purchase, and financing to manage cash flow as a continuous process. Let’s dive into each method.
The traditional method: Startup worksheet
The traditional method uses a startup worksheet, as shown in the illustration here below, to plan your initial financing. The example here is for a retail bicycle shop. It includes lists of startup expenses in the upper left, startup assets in the lower left, and startup funding on the right.
The total startup costs in this example are $124,650, the sum of expenses ($3,150), and assets ($121,500) required before lunch. The funding plan, on the right, shows that the owner plans to invest $25,000 of her own money and $99,650 in loans. The loans include a $70,000 long-term loan and other loans including a commercial credit of $17,650, a $2,000 note, and other current debt (probably credit card debt) of $10,000.
Notice the balance here. One side shows the startup costs and the other shows where the money will come from.
Notice also that the assets include $35,000 in cash and bank account. That estimate, in this example, comes from the example shown above, that calculates needing $25,708 in initial cash. The entrepreneur estimates $35,000 instead, to have a buffer.
Also, remember that the worksheet is about what happens before launch. It doesn’t include ongoing sales, costs, expenses, assets, and financing after launch.
This worksheet example shows an estimated $3,150 in expenses incurred before startup. That is the loss at startup, meaning that these expenses can be deducted against income later, for tax purposes. The loss at startup made sound bad on the surface, but having expenses to deduct from future taxes reduces tax bills. It’s quite normal. It’s also a good thing.
The LivePlan method: Consolidated estimates
LivePlan suggests a different and probably more intuitive way to estimate startup costs. The key difference between LivePlan and traditional methods is the estimates start when a business starts spending rather than when it launches and starts getting revenues. There is no division between the launch date and pre-launch spending. So there is no specific startup table.
For example, in the Soup There It Is sample business plan, the revenue starts in April—but the spending starts in January. As you can see in the illustration here below, this startup estimates $11,500 in startup expenses, including $4,000 each in January and March plus $3,500 in March.
And, in the balance sheet, you can see that the startup projects needing $30,000 in initial cash investment, of which $21,375 is left at the end of the startup period. Founders have spent $11,500 on startup expenses. Of that, they owe $2,875 in accounts payable. So remaining cash is the result of starting with $30,000 and spending $8,625 so far.
And the remaining $2,875 in accounts payable takes the sum of expenses up to the $11,500. Notice also that these deductible expenses create a loss at the startup of $11,500. (For a look at how these same numbers would show up in the traditional method, read on to the following section.)
And how do you estimate, with the LivePlan method? Start with revenues, costs, and expenses (including payroll). Add in assets. And then solve the resulting cash flow problem by adding financing including loans and investments.
For example, here is how the Soup There It Is balance sheet looked before the founders added investment, loans, and inventory:
Do you see the problem there? A business plan isn’t done until the projected cash balance is above zero at all times. Otherwise, checks are bouncing, the bank is up in arms, and the business in trouble.
So the founders, as they develop their plan, first project money coming in and out, and from that, they can estimate how much financing, including investment, they need to make that work.
Reconciling the two methods
What’s the difference between the two methods? The following illustration shows how the traditional startup worksheet would look in the Soup There It Is plan. The plan would start in April, not January. And what the LivePlan method shows as happening in January through March is consolidated into the startup worksheet. See if you can see these numbers in the projected balance sheet for the LivePlan method, above.
If you prefer the traditional startup worksheet method but are working with LivePlan, then you would set your starting date as April, not January; and you would set owner investment (in financing) as $30,000. You would use the starting balances option in LivePlan to set starting balances as $21,275 of cash, -$11,500 in retained earnings (the loss at startup), and $2,875 in starting accounts payable.
Things to consider when 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.
The launch month is often the first month of the business’s fiscal year
The establishment of a standard fiscal year plays a role in the 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 the startup financing in order to pay for them.
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 with realistic 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.