Starting a business can be exciting because it gives you the flexibility and freedom you can’t get in full-time employment. Launching a business can be exciting in the beginning but the energy dwindles with the passage of time. Actually, you may be forced to abandon your dream because of shortage of money to run it.
Setting a business running is not only a complex process, it’s also expensive. You need to conduct market research, find an office to rent, secure a permit, design a logo, create, social media account, a website or app before you open its doors.
All these activities have a price tag based on the kind of business you are starting. Therefore, you should have adequate capital to cover these organizational costs. Alternatively, you can apply for a loan to help you cover them because they’re an essential component of your business plan.
Learning how to determine startup costs will help you manage your cash flow, estimate future profits, calculate growth rate and make money.
So here are the parameters to consider when estimating your startup cost.
What are Startup Costs?
Costs vary based on the size of the business and industry. So there is no universal agreement on what startup expenses should be.
However, startup costs also known as preliminary expenses, startup expenses or pre-opening expenses include the expenses and assets a founder incur when establishing a new business. These are non-recurring expenditures you incur when starting your new business.
Some of the common costs are startup insurance fees, registration charges, legal fees, accountant’s fees and more.
It’s important to learn how to calculate startup costs because it gives you an overview of your business’s current and projected financials.
Here are the benefits of knowing the initial working capital.
Attract Investors: Angel investors and venture capitalists are more comfortable supporting a startup business that provides an accurate breakdown of its costs.
Correct Profit Estimate: An entrepreneur can easily and accurately predict profits when they know understands the business costs.
Can Put Plans in Place to Cover Fixed Costs: Calculating costs from the beginning helps you estimate the number of sales you need each month to cover any costs connected to starting a new business.
Identify Tax Deductions: Some costs are eligible for tax deductions so being able to identify them from the beginning can help you save money when making purchases.
Set Realistic Goals: Knowing how to calculate startup cost helps you set realistic goals, and avoid overexcitement during product launch which can lead to miscalculation and ruin your product’s and company’s reputation.
Parameters to Consider When Estimating Your Startup Cost
1. Cost of Minimum Viable Product (MVP)
After finalizing a start idea an entrepreneur should produce a prototype. The following is how they can about it.
Minimum Viable Product (MVP) is the first working product or prototype. Although it’s a basic product it means the life and future of your business and so you be careful when producing it. Actually, a faulty MVP can lead to production cost failures.
A cost is created when building an MVP. However, it’s not a single consolidated number because it has several other sub-costs that can influence its overall development process.
Ongoing vs One-Time Costs
A recurring cost comprises monthly or yearly costs. They are expenses that a business has to meet regularly such as web-based tools that you pay for continuously unless you unsubscribe, rent, payroll, business taxes, legal services, loan payments, business insurance payments, utilities, and marketing costs.
The one-off or one-time cost is a cost that you only pay for it once. For instance, the software lifetime licenses, hardware platforms, permits and legal fees, incorporation fees, logo designs, website designs, business cards and brochures, signage and real estate costs.
Direct vs Indirect Costs
Direct costs are linked with discrete areas of the project It includes hardware components costs, profits distributed among the members of the team and fuel.
Indirect costs can’t be attached to a particular expense head. Take for example running your startup at your home or garage. The power bill for building your product here is an indirect cost.
Human Capital Cost(s)
Even if you’re skilled and experienced enough building your product entirely by yourself is not practical because you will need an extra hand when you want to produce more which means an additional cost.
Entrepreneurs who ignore that cost encounters unpredictable outcomes, therefore, you should calculate the human capital cost for the entire MVP product development cycle duration. For instance, you can hire a web developer at hourly rates and calculate the cost of retaining him until project completion.
Opt for contractual employees when building your prototype and pay the team when it achieves the agreed milestones or completes the contractual obligations. Getting salaried employees regardless of their performance can be costly. Actually hiring university students and people from incubator programs can be less costly and are available to work.
Time vs Cost Penalty
The optimum duration for building a startup product is three months. At times a product can fail which means the entrepreneur has lost all that time and money spent during that duration.
An MVP duration that stretches beyond three-month can be costly and these expenses will run into the future. So use this duration to build a product that can be rolled out while monitoring the startup production cost.
Indeed, whenever possible your MVP should be the final product and give real users the opportunity to decide while you make changes to the MVP based on their feedback.
2. Startup Inventory Cost
An MVP is an iterative process that you keep on repeating until you achieve what the public actually wants. Startup inventory cost follows the end of the MVP phase and is the total inventory that you produce to support the project.
Overstocking can lead to startup fail. This is mostly caused by the failure to calculate the inventory cost forcing the company to produce more than the actual amount of orders they’re receiving from their customers.
Inventory Cost Estimation
As mentioned inventory stockpiling can cause losses but starting small and monitoring the overall inventory can be helpful. In other words, regularly calculate the inventory turnover ratio.
For instance, if your startup has moved from MVP to production phase and the forecasted monthly sales in 1000 units. Ordering 100 units in the first round is better than 1,000 units at the start of the month because the latter ties a lot of your capital.
Here is how to calculate the startup inventory leftover ratio.
Begin by calculating the Cost of Goods (COGS) and Average inventory
COGS = Starting inventory + Purchases – Ending Inventory
You should all necessary costs pertaining to inventory management to purchases. They include packaging, handling and shipping.
Average inventory = Starting inventory + Ending inventory
Inventory Turnover = COGS
Days Inventory Held = Days in Accounting Period
Inventory Turnover Ratio
The accounting period is usually 90 days while a high turnover ratio is when the inventory is held for less than 30 days.
Factors that cause the inventory turnover to fluctuate
Finances: The majority of startups have a small budget in the beginning and so they are not able to market their products effectively. The outcome of this is lower inventory turnover. However, with time the startup may start generating revenue and become profitable thus bolstering its marketing strategy.
Lead Time: The time that your product takes to reach your customer is the lead time. A longer lead time caused by delays reduces the overall turnover rate.
Supplier Reliability: A startup needs reliable suppliers for it to be successful. Always have a backup supplier because any delays in the delivery of your products can destroy your whole business.
Management problems: You should expect to experience management problems when the inventory managers have no major stake in the business. Since in a startup setup it’s only the founders that have a real stake in the company, they should closely monitor the inventory and request regular updates from the managers.
Focus on Your Goal: Always remember your goal and prepare to rework the production costs regularly in order to bring them down.
3. Sales and Marketing
It’s mandatory for a startup to constantly promote its products to the target market in order to bolster its sales. However, it’s vital to have a realistic sales and marketing budget to attract and retain customers.
Digital marketing is one of the most effective and less costly methods you can use to promote your startup business. Therefore are digital marketing methods that a startup can use to drive traffic and sales.
Paid Advertisement: Some startup founders prefer paid advertisement because it makes their brands more vocal and within search engines due to related keyword terms for a set budget.
Organic Marketing: This is a combination of content marketing and online PR. To create an impact the startup should a solid content strategy. Still, the marketing cost for a digital startup is different from the one for a brick and mortar startup, so the founder has to carefully choose their strategy and tactics.
Email Marketing: It’s the best method of contacting and converting potential customers especially when you have built a good customer database. Distributing highly targeted emails can generate leads as your business gains more exposure.
Website: Having a website is no longer a luxury but a requirement in this digital landscape. Today, the majority of businesses have a website and should yours too. You may opt to design and develop your website or outsource from web developers. Working with a professional is costly but it can save time and create a unique website that bolsters your online presence.
4. Build a Strong Founding Team
It’s having the right team that help a startup achieve its business goals. Therefore, founders should strive to build a strong founding team because it increases the potential of the business survival.
On the other hand, a weak team can cause shipping delays, operational inefficiency, organizational dysfunctions, growing debts and much more.
Here is how a startup business can build an effective team capable of delivering promising results.
This is a team that works on the same premises and is capable of delivering results and overcoming challenges. It’s a costly team because it’s expensive to acquire and retain top talent. However, building a strong in-house team is beneficial because it ensures an effective workflow and saves time that can be used elsewhere.
At times, build an in-house team can be too costly while outsourcing the services from an external team can be cheaper. So a business can opt to outsource to save on cost but its business processes will not remain efficient.
Management awkwardness and communication gaps are some of the reasons why an outsourced team may fail to deliver desired results.
It’s a team made up of an in-house and outsourced team that works on interdependent tasks or shares responsibility in different projects but in different locations.
The in-house team works within the startup premises and its goal is to ensure smooth workflow and the delivery of the desired results. They are mostly made up of specialized, experienced individuals with a broader skillset.
On the other hand, the company may outsource less costly talents to fulfil petty tasks in order to allow the in-house team to concentrate on core business activities.
Usually, the cost of a hybrid team varies based on the team size and the goal that the business wants to accomplish.
Some of the initial costs that a startup incurs are deductible startup costs such as purchasing equipment and supplies or refurbishing the front ready for the MVP.
According to Internal Revenue Service (IRS), deductible costs are capital expenses and will benefit your business for years. In view of that, you’re required to deduct and depreciate the expenses as time passes.
Taxes are paid yearly and so it is important to allocate a percentage or some amount to taxes based on the revenue your business generates.
Because it’s not always easy to predict this amount, you can work with an accountant who has know-how on what deductions you can make in order to lower your taxes.
Startup Costs You Should Avoid
There are some costs that your business should avoid at its early growth stages. These are;
Subscription-based Services: Use free alternatives whenever possible instead of subscribing to expensive services at this stage. You can also stick to these until you are sure that business can longer function well without advanced features that are only available on the paid plan.
Expensive Assets: It’s tempting to invest in new technology but that doesn’t mean that it’s what your business needs. So instead of spending a lot of money on the latest technology, you try to be as economical as possible.
A Fancy Office: Your team will not be delighted working in a small, squeezed, poorly lit office situated at the end of the lane. However, that should not be the reason for renting a huge office and furnishing it with expensive furniture. Instead of dwelling so much on how your office looks like you should focus your attention on the success of your business. A big fancy office can wait until a later date when it’s extremely necessary to maintain one.
Getting into Debts: The new for a fancy office, latest technology, or services with advanced features can cause you to get into huge debts. Actually, spending a lot of money on irrelevant things before you become profitable can contribute to your startup failure. As humans, our business should operate within its means.
Unquantifiable Outreach Efforts: All your branding, marketing and PR efforts should be measurable, otherwise, you shouldn’t spend money on such activities. Instead of that, you should focus on activities that have a higher return on investment.
Which are Startup Assets?
Since you now know all startups costs that you should consider when launching your business, it’s also important to know its assets.
Business assets are long-term items that your company invests in and which it requires during the financing. These includes:
Beginning Inventory: The cost of all inventory or stock your business has and that it can use to generate revenue.
Cash and Operating Liquidity: These are invested funds aside from loans and other debts. You should consider them as assets and account for them.
Technical Equipment: These are computers, software, servers, headsets, cameras, printers, and more, that your business needs to operate.
Office Furniture: These are seats, tables, cabinets, etc.
Office Equipment: They include cleaning, storage, recordkeeping, bookkeeping equipment or those that perform other essential purposes.
Company Vehicles: Cars that the business owns for employee use or those that the company leases.
Expect Making Losses
While it’s okay to fail, it’s not right to make mistakes, not learn from them and to repeat them. The majority of successful startups failed at one time but none of them regrets it because they learnt from their mistakes.
For instance, your MVP may fail to excite your target audience or receive a lower turnover ratio than expected. Instead, take a break, evaluate what went wrong and talk to experts on how you can improve things and generate viable solutions.
Continue learning and driving your startup business into profitability.
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