Stage 5: Calculating Costs
Step 20: Determine Initial Costs
The Concept:
Before launching your business you need to determine the one-time costs you will incur for start-up.
What you need to know:
The smart entrepreneur needs to know exactly what the startup costs will be for the business, and makes sure there's more than enough capital to begin the operation and to cover any contingencies. Launching an under-funded business is a risky enterprise.
In general, you need at least 20% to 30% of the "bottom line" to begin a business. You also need to consider the impact of cash flow. Most likely, some of your initial capital will be needed for cash flow until the business generates money that is collected. Once you determine the specific amount of capital that you need, what steps will you take to make sure all of it is available? If necessary, wait until the necessary capital is available before starting your business.
Start-up expenses will be incurred to lease or purchase a physical facility, which may also need remodeling, and to "turn on" utilities. Costs will also come from equipment, supplies (such as office furniture) and services needed to run the business, manufacturing equipment and legal and accounting fees. You may also need to obtain permits or train your employees.
Following are examples of items to consider when determining start-up costs:
- Lease Deposit
- Facility Purchase, Improvements and Construction
- Tenant Build-Out or Tenant Improvement Costs
- Design/Architectural Fees
- Security and Utility Deposits
- Production Equipment
- Office Furniture and Supplies
- Legal and Accounting Fees
- Licenses and Permits
- Market Research
- Initial Advertising/Promotions
- Training
- Beginning Inventory
- Insurance Premiums
My total startup costs are $____________
Step 21: Compile Business Budgets
The Concept:
Business budgets, once compiled, will determine whether or not the business will work. Adjustments may be needed for the business to succeed.
What you need to know:
To compile your business budgets, pull together all of the projected start-up and ongoing costs previously determined, as well as all of your projected income, which includes loans, sales and investments. If necessary, an accounting professional can help compile your business budgets.
Your business/financial plan always is a work in progress. At a minimum, you should plan to produce an 18-month plan and review it every six months. A bank, however, will want to see a 3-year plan with the first year clearly compiled on a month-by-month basis.
The first step is to look at your projected Cash Flow Statement. This serves as a checkpoint to see if the business will work on paper. Enter all projected cash and all cash to be paid out such as expenses, loan payments and owner draws. Enter cash when it is received (i.e., receivables collected 40 days after sale) and when it is spent (i.e., payment to a supplier within 30 day terms). Be sure to include cash and expenses for the period prior to opening. If the ending cash total is negative your business cannot pay its bills! This projection should be on a monthly basis for at least one year. Seasonal businesses may find a two-year projection helpful to accurately in determine viability.
Estimating is part of the budgeting process but estimates should be based on a quote, assumption, industry standard or market research. The smart entrepreneur uses conservative estimates of sales and income, and liberal estimates of all expenses. It's also helpful to develop best and worst case scenario budgets to determine your chances of success.
The second step is to develop your projected Profit and Loss Statement. Enter all projected income and expenses. Keep in mind that interest on a loan is an expense while the principle paid on a loan is not. Also, loans are not on this statement nor are owner draws against profits. In a viable business, income will exceed expenses after the initial startup phase. In a seasonal business, income will exceed expenses on an annual basis but may not during some months when losses are incurred. A one-year projection by month is needed, and quarterly projections for the second and third year of operation are helpful.
Your Balance Sheet will help you determine your equity, or net worth. This should be a positive number that will grow over time. A three-year annual projection is helpful.
The final step is to develop your Budget Assumptions, which also are called budget explanations. You need to be able to explain, with some degree of confidence, each budgeted item as well as which assumptions, information or market research you used in the process. It is best to state which assumptions you based the budget on and your reasoning for selecting those assumptions. Recognize and consider as many factors (internal and external) as you can that may affect your budget.
Points to consider:
- Does the cash flow show negative ending cash at any time? (If so, a strategy to increase sales, cut expenses or obtain more money in investments or loans is needed to address this issue.)
- Have you formulated estimated budgets using more than one method of determining your estimates?
- Have you developed both best and worst case scenarios?
- How much funding is necessary to operate the business until it is self-sustaining?
- Given the projections above, will your business meet your financial goals? Should you continue? Restructure?
- Why did you develop the budget assumptions the way that you did?
Step 22: Calculate Breakeven Point
The Concept:
A new entrepreneur must calculate a very important piece of data -- the breakeven point -- to fully grasp the relationships of price, cost and volume and how they affect the company.
What you need to know:
Stated simply, the breakeven point shows what level of sales (in unit volume or dollars) is needed to offset all fixed costs of doing business and the variable costs of producing products. Fixed costs are expenditures on which the level of sales has no effect, including rent and loan or lease payments. Variable costs are affected directly by sales volume and can include labor wages and utilities. For instance, costs for hourly workers and electrical consumption can fluctuate a few dollars per month, depending upon how sales are proceeding.
The equation is easy: Fixed costs divided by the retail price of the product minus the variable costs to produce the product. If, for instance, your fixed costs total $900 per month, and your product sells for $50 but costs $25 to produce, your breakeven point is calculated like this:
$900 / ($50 - $25) = 36 units sold to break even.
Points to consider:
- Is the break-even point attainable?
- Given market conditions, can it be exceeded?
- Given market conditions, is this business proposal still viable? Will the marketplace allow sales to be at a level that you can meet financial goals?
