Estimating startup costs

Estimating startup costs

28 Sep, 2007, 0300 hrs IST

One of the toughest things in starting
a business is, well, figuring out what it’s going to cost you to start.
It’s tough because startup costs are a moving target, easy to
underestimate and almost always subject to change. Here are five rules that can
help you start figuring the cost of starting.

Have a solid plan
— then change it. Most business startup stories say that you have to have
a business plan. And you do. But that’s not the beginning and end of
figuring out your startup costs. Jeff Shuman, professor of management and
director of entrepreneurial studies at Bentley College, says, “The
conventional wisdom is that an entrepreneur sees an opportunity, comes up with a
business plan to capitalise on it, determines the capital that needs to be
raised, raises the capital and then applies it to building the business
described in the business plan.”

There’s one major
problem with that model, says Shuman: It all hinges on getting the business
right the first time, and that doesn’t often happen. “In reality,
it’s likely that some of your initial assumptions are pretty good and
others aren’t going to be worth the paper they’re written on,”
he says. Shuman and others say that figuring out your startup costs means
regularly reviewing your assumptions and changing your initial business
model.

Writing a business plan is good because it forces you to write
down literally everything you are going to need to start your business —
legal help, tax help, office supplies, equipment, postage, office space,
employee salaries, insurance and so on. But that initial plan is likely to
change repeatedly as you learn new things and incorporate them into the
plan.

Be willing to pull back. It’s tempting to add up
everything you need for the full-fledged business you imagine, and decide that
that’s what you need to start out. But pulling back and looking for a
smaller model can give you a way to get started while also preserving
capital.

Shuman uses the example of someone who calculates that the
total cost of starting a retail business in a local mall is going to work out to
$150 a square foot. “You could start that way and write a business plan
based on that amount,” he says. “But maybe you’d be better off
putting a pushcart in the mall and testing what the demand is for your products
at that location.

“This consumer testing reduces your initial
startup costs. The result is that the initial cycle of your business is
dedicated not so much to generating profits as to generating information. With
this, you can fund your business on a cycle-by-cycle basis,” Shuman says.
“When you go for the second cycle and for expanding your business, the
numbers are now based not on focus groups or surveys but on real-world
experience.”

Calculate prices, time correctly. Calculating your
initial cash flow is part of figuring out your startup costs. It’s an area
where businesses are sometimes less optimistic than they should be.
“Small-business owners may under-price their product or service, thinking
they have to come in at as low a price point as possible to compete,” says
Barbara Bird, chair of the management department at Kogad School of Business at
American University. “They don’t necessarily need to do
that.”

Correctly estimate your startup time. Yes, when
beginning a business, time can literally be money. Let’s say you’re
going to have fixed costs such as a monthly lease. If you have to make
improvements to a space before you can actually open for business, those fixed
costs are going to be additional startup costs until you can actually open for
business.

I’ve watched many entrepreneurs draw up a timeline
for their ventures and get tripped up on the zoning, safety and inspection
requirements imposed by local agencies. For that reason, I think one of the
first places a prospective new business owner should go — even before
approaching a lender or leasing agent — is to the local government
planning or license department. Construction permits and inspections can push a
startup’s prospective opening date back by months. If you fail to figure
in the cost of this additional time, you could be short of working capital right
out of the gate.

Be realistic about the cost of money. Many
small-business owners self-finance their ventures by running up big balances on
their personal credit cards. Others tap the equity in their homes. But
self-financing isn’t a practical option for larger
ventures.

Carnegie Mellon’s Emerson says that startups should
figure in the cost of capital when determining initial expenses and cash flow.
“The cost is usually based on what the interest would be that similar cash
invested in something with similar risk would command on the market,”
Emerson says. “It’s usually a figure that is a few percentage points
or more above the prime
rate.”

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