The majority of new businesses fail within five years, many because they make too little money and spend too much. In the early years, maintaining tight control of costs and knowing exactly what needs to be spent is essential. Business owners that don’t know how much they will be spending each week risk significant trouble if costs suddenly spiral out of control. Projecting start-up costs in the short and long-term is essential to building a profitable and sustainable business.
What are start-up costs?
Start-up costs refer to money spent to get the business off the ground. Where outgoings stop counting as start-up financing and turn into day-to-day spending is a matter of opinion. One common definition is that start-up costs are non-recurring costs involved in the setting up of the business (such as legal and accounting fees), although some entrepreneurs would also include the initial purchase of stock as a start-up cost.
For practical purposes it’s useful to include regular outgoings in your start-up costs so you can more easily gauge your break-even point in the first few years of operation.
Start-up costs include two types of cost: fixed and variable. Fixed costs are those that do not increase based on the number of products you sell, while variable costs are those that do. Here are some of the most common fixed and variable costs when starting up a business:
- Insurance: taking out insurance will be essential when you first start the business, and will include public liability insurance and – if you employ staff – employer’s liability insurance
- Legal fees: any advice taken before setting up your business, including intellectual property advice, or fees related to registering the company at Companies House
- Accounting fees: money paid to a professional accountant who provides advice in the early stages, for example on making the business as tax-efficient as possible
- Commercial property: buying or renting premises for your business, including refitting, utilities costs and signage
- Recruitment and selection: advertising vacancies, paying recruiters, costs of standard benefits for employees
- Stock: products and raw materials as well as warehousing to store your goods
- Individual product cost: how much you pay a supplier for goods; generally the more you buy, the less you’ll pay per item
- Delivery: the cost of packing and shipping (and perhaps insuring) goods to your customers, which will decrease as the number of items you send increases
- Staff wages: different staff will receive different remuneration packages, and the amount you spend on staff wages can change if new people are hired or if employees quit.
Why predict your start-up costs?
To remain afloat, businesses must make a profit. If monthly outgoings exceed monthly revenue, the business can’t make a profit and it will fail. Projecting start-up costs allow you to work out your break-even point i.e. when you spend the same as you make. This is a key piece of knowledge – if you know the break-even point each month you know how much money you need to make in order to turn a profit.
Another reason to predict your start-up costs is to help avoid unnecessary surprises or spikes in spending that cause a cash flow crisis. If you analyse your business and see where potential spikes in spending could occur, there’s less chance of an unexpected cost ruining your profit for that month. Knowledge is power when it comes to profit – if you have a solid handle on your start-up costs then you’re moving in the right direction.
Build your own list of costs
The list of costs above can help you estimate your start-up costs, but it is not exhaustive. Each business is unique and will have unique costs that must be considered, such as complying with relevant legislation.
Your first task is to make a definitive list of all expected outgoings for a set period of time, such as one year. For each item, add a predicted figure and then total up all the figures to get your rough estimate for outgoings for the defined period of time.
What’s the best way to make a list of potential costs without missing anything? There’s a lot of information to be found online, and you can learn from other entrepreneurs. One quite innovative way is borrowed from prisoners war who, in order to cope with intense isolation, build entire houses in their head, down to the last screw. They’ll perform each action (sawing, measuring, drilling) in real time, in effect living the actual construction process in their minds.
The method used in this incredible display of perseverance is a long-winded but useful tool to help estimate your start-up costs. By imagining your business unfolding and considering each step in the process, you’ll be able to see precisely what you’ll need and what you’ll spend.
It may seem overkill, and the metaphor is indicative rather than absolute, but it can really help you get to grips with not only the costs but the process of starting a business. It can also help you produce a worthwhile business plan, a cornerstone of accurately projecting your costs.
The business plan
The most useful way to accurately project start-up costs is to have an accurate business plan in place. A business plan details how you will run and grow the business, what action you will take and when, what setbacks could occur, how you’ll overcome them, and how your finances will look at each stage of growth.
Good business plans are expansive, well-thought out documents. They should be as all-encompassing as possible (without being restrictive) so that all potential costs are identified as early as possible.
It’s very important that a business plan details not only what you’ll do in certain eventualities, but also how you’ll do it, particularly if you plan on presenting to investors.
Be pragmatic and realistic
Start-up costs mount up very easily. The figure you finally reach will be generally accurate (if you’ve put the effort in), but it’s unlikely you’ll have spotted absolutely everything. That’s why it’s good to add a percentage onto your start-up costs to make sure you are always working within comfortable limits.
A popular business maxim is to ‘double your costs and halve your revenue,’ particularly in the early stages of operation, in order to insulate the business from unexpected surprises. While this approach may be unaffordable by many businesses, it offers a glimpse into the mindset that should be adopted – costs can cripple a business, so be aware of potential eventualities and never take your eye off the outgoings.