Estimating Realistic Startup Costs
This article is part of our Business Startup Guide—a curated list of our articles that will get you up and running in no time!
What will it cost to start that business? Of course, you can’t know for sure, but you can work with reasonable estimates. You can break down the problem into simple lists and work through the lists. It’s always a guess—but you can make it a good educated guess. Here’s how.
Startup expenses are those expenses incurred before the business is running. Many people underestimate startup costs and start their business in a haphazard, unplanned way. This can work, but it is usually much harder. Estimating realistic startup costs is one of the key elements of your financial plan. Customers are wary of brand new businesses with makeshift logistics, and you can’t figure out how to manage startup costs until you calculate them accurately.
What are startup costs?
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.
Two essential lists:
Startup costs normally include startup expenses and startup assets:
- Startup expenses: These are expenses that happen before you launch and start bringing in any revenue. For example, many new companies incur expenses for legal work, logo design, brochures, location site selection and improvements, and other expenses. Startup expenses also include expenses such as rent and payroll that start before launch and continue from then on.
- Startup assets: Typical startup assets are cash (in the form of the money in the bank when the company starts), and in many cases, starting inventory. Other starting assets might be either current or long-term assets, such as equipment, office furniture, vehicles, and so on.
Cash balance on starting date
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 starting date is the money you raised as investments or loans minus the cash you spend on expenses and assets.
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. Many entrepreneurs decide they want to raise more cash than they need so they’ll have money left over for contingencies.
However, although 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, after launch, from launch until you reach a monthly break-even state in which revenues are equal to spending.
Most new businesses take months and sometimes even years from launch until reaching that steady-state break-even point. I have an example in the illustration below. The startup in question estimates it needs $25,708 in startup cash to cover the deficit spending from January through June (that’s the number in the May column for cash balance).
Obviously, the real world is not as reliable as pre-launch estimates, so the right number for this business, for planning purposes, is probably $30,000 or more. But even six months of spending would be about $240,000 (an eyeball estimate based on the row in the illustration called “total spent”). That kind of cash in the bank would be nice, but usually completely unattainable.