Start Up Costs
The Making Business Fun Podcast, Episode #105
# 105 Startup Costs
The companion Google Spreadsheet for this podcast can be found here.
Absolutely, one of the least fun things about owning a business is having money trouble. Truly, not having enough money, not making enough money, or not being profitable enough, to keep your business going, is very very not fun.
Today, we are going to take a look at two very specific sets of numbers. First, we are going to take a look at the costs to start your business. These are, the costs, the money you must spend, to get your doors open.
The second set of numbers that we are going to look at, is the monthly operational costs — overhead — and your sales break even point. That is, how much of your stuff you need to sell every day, week or month, to be profitable. Being profitable, of course, has a direct effect on how long you stay in business. Generally speaking, businesses that make lots of profit stick around for a long time, and businesses that don’t make profit don’t last that long.
This is quickly going to feel like it's getting complicated. But I promise you, it is not. In fact, in an effort to keep things not complicated and fun, I have gone ahead and prepared a pretty awesome spreadsheet template to help you calculate both of these costs. And I would urge you to go grab yourself a copy of the spreadsheet because it's going to make things a whole lot easier for you.
You can find the spreadsheet at ericgoeres.com/resources. I'll tell you right now, when you go to get the spreadsheet, you were going to be asked to join my mailing list. I would encourage you to do so, because I'm not going to spam you, and anything I sent you in the future, is only going to be helpful. And, always, there's going to be an unsubscribe link at the bottom of every email, so that’s your fast way out.
So yeah, go get yourself a copy of the spreadsheet, ericgoeres.com/resources, open it up on your computer, and take a good look at it while we discuss the topic of today's podcast: start up costs, and costs of sustaining operations.
**The Process**
As was almost everything in business, there is a process. So often, those who are not familiar with running a small business, think that running a small business is some combination of a magic trick and dumb fool luck. That's not the case, at all. These are typically the same people that assume an airplane pilot is constantly upfront juggling levers, paddles, steering wheels, and buttons, in a chaotic frenzy, to keep the plane in the air. Nothing could be further from the truth. In fact, almost all aspects of the business, can be boiled down to some very simple rules, processes, and tasks, that when executed in the proper way, and in the proper order, will lead to a well running, well organized, well understood, profitable and fun business to run.
Are process here is very simple, and a fast four steps. I'll run through them very quickly now. Step one, we add up all the start up expenses. Step two, we add up all of the assets that you will need to purchase to get your doors open. Step three, we are going to add up your ongoing monthly expenses — otherwise known as overhead. And then finally, step four, we are going to calculate the amount of sales revenue that you must exceed to keep the doors open. Otherwise known as, your break even point.
We're gonna do all of this on a spreadsheet, in categories, and I've already taken the liberty of putting a bunch of sample costs assets and expenses into the spreadsheet. You are going to want to use some of the categories and items that I put in the spreadsheet, and you're going to want to delete out some others, and you're going to want to add some of your own. If you are unclear on how to add rows and remove rows and otherwise goof around in a spreadsheet, it would behoove you to do a quick Google search on spreadsheet basics, because working a spreadsheet is a good thing for a business owner to know to do.
Anyway, in this spreadsheet, you're going to be asked to put in a bunch of numbers. Some of these you will know outright, like your rent, you probably know that by now. Others, you may have to make an educated guess, such as the electric bill. Others still, will be estimates from a third party. For example, you may have an estimate of $500 to put a sign on the front of your store, but you know that's an estimate, and it could go up, or it could go down.
Don't be scared to make educated guesses, don't be scared to use estimates. You don't have to get these numbers exactly 100% right now. We're really just trying to construct a good look at what these costs are going to be.
But hey — when you’re guessing and estimating, be conservative.
Where you are plugging in these numbers, with expenses, I am going to encourage you to assume that things are going to be a little more expensive than you think. Even if the expense is an estimate from a vendor, it's probably safe to assume that the actual work may wind up costing you a little bit more: maybe 10%, maybe 20%. Those are safe cost over-run amounts.
And then when it comes to the sales figures, I'm going to encourage you to be a little bit conservative. If you think your business is going to bring in $100 or $1000 a day, I'm going to encourage than you use $75 or $750 in your estimates, just to give yourself a little room for error, and also to keep things relatively safe.
There's a very well-known and well understood phenomenon out there that tricks business planners into underestimating their costs and over estimating their revenues. It’s known as the Planning Fallacy and it says that not only do we overestimate the awesomeness, we simultaneously underestimate just how much we’re overestimating. The Planning fallacy. Don't fall into the trap.
**Costs to Open the Doors**
The first set of dollars and cents that we are going to concern ourselves with are the dollar costs required to get the doors open. These costs fall into two clear categories. The first category is start up **expenses**, and the second category is **assets** to purchase. Start up expenses, assets to purchase.
And a quick note, as you are toying around with setting up your business, you're going to want to make lists of these expenses, and be adding them up and being aware of their costs and totals. That makes perfect sense. You can use the spreadsheet that I prepared, which will make it very easy, or you can create a spreadsheet of your own to capture these expenses and add it all up.
Which is better, using my spreadsheet or making one of your own? It depends. If you use my spreadsheet to capture all these expenses, it's going to be relatively really easy to get started. On the other hand, if you create your own spreadsheet from scratch, it's going to take a little bit longer, but it might be a little bit better suited for what exactly you're trying to do, specifically for the type of business you are starting. The other advantage to creating your own spreadsheet from scratch, is that you will have a very good understanding of how the spreadsheet works: its calculations, its formulas, its organization and structure.
And, there's certainly nothing wrong with downloading my spreadsheet, taking a good look at how it works, and then creating your own from scratch. That's totally cool, and often a really good way to get started.
And yet, if you wanna grab a yellow legal pad and a calculator and a pen or pencil, and go at it from there, go for it. That’s totally acceptable and often a really easy way to get the thinking out of your head and onto paper. This so-called back of the envelope pencil-and-calculator work is a lot of times a real quick way to figure out what’s going on. And even the simplest calculations are better than no calculations.
OK so let's get into the first two cost categories.
The first one is start up expenses, the other one is assets.
An expense is a cost that a company pays to operate, whereas an asset is a long-term tangible thing that a business owns and uses for business operations and to facilitate sales revenue.
What's the difference? Well these start-up expenses are one time start up fees, services, deposits and other expenses that are required to start the business.
For example, if you pay a $300 fee to a lawyer to make your company a legal LLC, that's a one time start up expense, that has to be paid, and does not produce a tangible asset. It’s paying for a service. A $50 filing fee for a business license is a one-time start up expense as well.
The second category of start-up costs is, in fact assets, that you have to purchase. Typical assets are things like your delivery scoters, your cash registers, your shelves and the inventory that you need to buy to start your business. One key distinction about assets, is that assets wind up listed on the companies balance sheet, whereas start up expenses don’t, since start up expenses are just money spent, the same way a phone bill doesn’t go on a balance sheet.
In the case of the start up costs spreadsheet that I've prepared, I have broken my start up expenses into five categories. Those categories are, number one, business formation costs; number two, physical costs; number three, sales and marketing costs; number four, one time operating costs; and number five, miscellaneous and other costs. And now is probably a good time to remind you that all of this information will be posted in the show notes on the Making Business Fun Podcast, Episode 105 blog post at ericgoeres.com. So, no need to take notes, you can find it all at the website.
Five categories: business formation costs, physical costs, sales and marketing, one time costs, and miscellaneous. Going into each of these, one by one, very quickly, business formation costs includes things associated with actually forming the business. That’s usually things like fees paid to a lawyer to set up the company, fees paid for licenses and permits, and fees paid to an accounting firm to set you up in QuickBooks and whatever else.
Category two, physical costs, this includes the physical stuff you have to do to your place of business to get it ready to open the doors. This includes all costs related to renovating or fixing up or building out or otherwise rejuvenating the space in which you’re going to be doing business, as well as the work permits required to do that work. Gotta put in a dressing room? That’s a build-out cost and it goes right here.
Category three, is sales and marketing. Of course you're going to need some things in the sales and marketing realm to get your business started. These are expenses like your brand development, logo design and all that jazz, the sales and marketing materials required, such as menu design, take-out menus, business cards, brochures. And also, the sales and marketing category, includes the build out of your website.
On that topic, For those of you who need a business website to be set up very quickly, very easily, and quite inexpensively, consider checking out our good friends at upinaday.info, a company that specializes in very quick custom websites for new businesses that are getting started. We talked a bunch about them in Episode 104 of the Making Business Fun Podcast, Brand Building Blocks.
Next category, is one time operating costs. This includes things like deposits that you paid the landlord and deposits you pay to city utilities, for example. And, the last category is miscellaneous and other. And of course, this category is exactly that. If you have other costs, that are expenses and not assets, you can put them here in miscellaneous and other.
OK, get all those numbers in there and total it up. And then let's move onto step two in the process, making a list of all the stuff — the assets — that we need to purchase to get the doors open.
Again, an asset is something that you purchased that has real value, that is sort of tangible, and lives not only at your place of business, but also on your balance sheet. We have five categories of assets to consider.
First category is real estate expenses, trucks and automobiles. If you're going to buy a building, or cars, trucks, or delivery scooters, for your business, then here is where you list it. If you're buying a Nissan delivery van for $30,000. This is where the $30,000 goes. Quick note — if you're leasing that van, then only the down payment would go here and the monthly payments would go into the monthly operating expenses, that we will touch upon later. Same if you are mortgaging the property you are purchasing: the down payment goes here, and the mortgage payment goes in the monthly expenses. OK, that's category one: real estate trucks and auto.
Category two: furniture and fixtures. This is going to include counters, shelves, racks, light fixtures, signage, chairs, desks, booths, tables, and all the other hard assets that it takes to operate your business. Not too complicated.
Category three, equipment and machinery. This is going to include the computers you buy, the point-of-sale system, and all the other equipment and machines you need. At a restaurant, it's an oven and a refrigerator. At a warehouse, it's carts and forklifts. At a hair salon, this is blow dryers and clippers.
Next up, category four, inventory and supplies. This is the stuff that you are going to need on the shelves, available for your customers to buy, on day one. If you're doing retail, this is all your T-shirts and jeans. If you're doing a restaurant this, is all your unprepared food, the steaks and fishes. If you were a shoe store, this is all the shoes, sitting in boxes, in the back room, waiting to get sold.
And last, category five: miscellaneous and other. Again this is the catch-all where whatever other hard assets you need to purchase, they go right here. Like, if you had to purchase a salt water aquarium and more fishes and rocks and castles, i guess that would be a good use of miscellaneous expense lines.
And, there you have it. Now you have a big handy list, a list of all the things you need to spend money on, to get your doors opened, pretty cool huh? I will say, at this point you may be looking at that number and thinking, “man, that is a lot of money.” But don't worry, soon we are going to be looking at the revenues and profits, and that will bring things into perspective.
And oh my god, don’t you all of a sudden feel so prepared and businessperson-like with your spreadsheets and numbers and stuff. It’s cool right? You’re cool.
**Monthly Operating Expenses**
Operating expenses are the expenses required to, imagine this, operate the business. Before now, all of our costs have been one-time start-up expenses. These monthly expenses are recurring expenses — month after month, for the life of your business. Like rent, is a good example. There are basically five quick categories of operating expenses, and they are: facilities, personnel, what I call moving and shaking, operations, and or old pal, miscellaneous.
In the first category of monthly operating expenses, facilities, expenses are going to include things like rent, utilities, insurance, telephones, Internet, and supplies. Category number two, personnel, it's going to include your payroll, the owner’s draw, and any bonuses that you may be paying to your people. Category three, I call it moving and shaking, and it encompasses things like transportation costs, gas, tolls, postage and shipping, and expenses generally associated with getting things on the move. Category four, operations, includes a good bit of back office kind of stuff, such as legal and accounting fees, advertising and marketing expenses, and debt repayment. Yeah, you heard me: debt repayment.
If you have borrowed money to open this business, and you are required to make a monthly payment on that loan, that goes right here, as an operations expense, under debt repayment. And then of course, category five, miscellaneous and other, feel free to stuff whatever other junk you have as a monthly operating expense in right here. Like adding more salt to the aquarium and fish food and live plants.
Add up all these monthly operating expenses, in all their little operating expenses categories and you will arrive at a total number of what it’s going to cost to keep your business operating. We can call this operating expenses, but since they are not directly tied to the things you're selling, for example the T-shirts on the racks, this number also represents your overhead.
One thing to consider when you're getting started, is how many months of operating expenses you would like to have in reserve at the time that you open the doors. Knowing that you're not going to have a bazillion customers on day one, it is often advisable to have a little cushion money sitting around. The professors say it’s smart to six months of operating expenses sitting around waiting for problems. And they were proved right when the pandemic came around and closed everyone up for six months.
But it’s expensive enough opening a business without a six-month cushion. So, can you open your business with less than six months of monthly operating expenses held in reserve? Yes you can. And it's done all the time.
But it makes things a little more complicated and a little bit less fun. It can get stressful, if the money’s real tight all the time. See if you can open with four months, or three or two months, worth of operating expenses set aside for unforeseen problems.
**Profit Margins**
At this point, we know all the costs to get the doors open, and we know what the monthly operating costs are going to be.
The next thing that we need to concern ourselves with, is gross profit margin. If you have any questions about profit margin, definitely pick up a business handbook or do a Google search, and get a quick understanding of how profit margin works.
In its most basic terms, gross profit margin is the percentage of your sales revenue, which is gross profit. For example, if your pricing policy is to set retail prices at double what wholesale prices are, then if your t-shirts cost $10 a piece wholesale, you will be selling them for $20 retail. And that means that of every $20 of sales, $10 will be gross profit. Thus, you have a 50% gross profit margin.
And this is a function of the cost of goods sold (COGS) only. At this point, gross profit margin doesn’t worry about overhead — only the cost of the stuff we’re selling.
If my company makes something that costs $3 to make, and I sell it for $10, then I have a $7 profit. That means 7 out of every 10 dollars is gross profit and therefore I have a 70% gross profit margin. If the wholesale price of a piece of steak and a fistful of french fries costs $15 and my restaurant sells it for $20, then I have a 25% gross profit margin.
I am spending a minute on this because steadfastly sticking to your business’s pricing strategy and declared gross profit margin is key to success. If you have a small gross profit margin, generally that means you have to move a lot of product very efficiently. Low gross profit margin and slow sales typically means you’re going out of business. Gotta watch those margins.
And different kinds of businesses have different kinds of gross profit margins. And it's important to know what the average profit margin is for your kind of business, because we are going to use it now to determine your break even point. I hear a law office typically has a 93% gross profit margin. I also hear that a car dealership can expect a 14% gross profit margin.
A lot of times you hear stuff like “restaurants have super thing profit margins.” And then you walk in and see a $70 steak on the menu. That seems like plenty of margin, right? Because you can buy a damn good steak at Costco for $20. Places like restaurants have pretty good gross margins — but they get killed on rent and other operating expenses. It’s said that restaurants have good gross margins — a $15 steak dinner selling for $70 — but thin operating margins, because the operating margins also include the expenses of the waiters, the busboys, the rent, the upkeep and all the other stuff it takes to make a restaurant work.
My point: know what your gross profit margin should be for your industry, and price your merchandise accordingly.
**Break Even Points**
The breakeven point is the amount of sales you much must do on a hour day week or month, or even year, for your business to break even.
And breakeven, to be clear, is the point at which your company is generating enough sales revenue to be profitable, or not. If your sales are above the break even point, you’re making money. If your sales are below your break even, you’re losing money.
And of course, you look at breakeven's on many different time scales, because it's very possible you can be operating below breakeven on a few days of the week, and then operating above breakeven other days of the week and end up above break even for the week. For example, many bars and restaurants operate below break even on Mondays and Tuesdays, and operate wildly above break even on Fridays and Saturdays, and they end up being above break even for the week. So, when we calculate your break even points, we will be doing so on a daily weekly and monthly basis, so you can look at it a few ways.
Let's start with your monthly break even figures, and we're starting with monthly because we have just calculated what our ongoing monthly expenses are. And to get to that monthly break even point, all we do is take the total ongoing monthly expenses, and multiply that by the profit margin. For example, if our monthly operating expenses are $100, and our profit margin is 50%, then that means we must sell $200 worth of merchandise per month to cover the $100 in operating monthly expenses. And if we must sell $200 a month cover our overhead and be profitable then we can quickly divide that by the number of weeks in a month, or by the number of days we are open within the month, to get our weekly and daily sales breakeven points.
And of course, you want to know your breakeven points, so that you can set sales goals for the days weeks and months that your business is operating. In our example above, with $100 a month in operating expenses, otherwise known as overhead, and 50% profit margin we know we need to sell $200 a month worth of merchandise to breakeven and that translates to $50 a week to breakeven or if we are open six days a week, eight dollars a day to breakeven.
**Final Startup Expenses Total**
And, in the end, we want to get to a figure that represents the total amount of cash you need to have on hand to get your business started. This is a little bit of addition, and a little bit of multiplication. First thing we do is add up your total start up expenses and your start up assets to purchase, and we arrive at the total cost to get your doors open.
Next we take a look at your ongoing monthly expenses, and we think about how many months of reserve operating expenses you would have in the bank. Earlier in the podcast we talked about the wisdom of having six months of operating expenses on hand, but for some people that's going to be impossible.
And businesses often open their doors with less than six months of cash on hand — so how many months do you want to have on hand as a safety net, it's up to you. Let's say it's three months. Now you wanna take your total monthly operate expenses and multiply that by three months, and the total is your reserve. Take your reserve, and add it to the total cost to open the doors that we just calculated a few minutes ago, and you get the total amount of cash you need to have to get your business open.
And like I said, this is an awful lot to absorb in the abstract, but it's pretty easy to pick up visually, and I would certainly advise you to go to ericgoeres.com/resources to get the spreadsheet that corresponds to this Make Business Fun Podcast, Episode #105. Looking at the spreadsheet, things will become crystal clear.
In short, take start up expenses, plus the total start up assets to purchase, plus your ongoing monthly expenses multiplied by the number of months you wanna have in reserve, add it all up and you get the stack of cash you need to open your business.
Additionally, we've done the work required to find your break even point at the monthly weekly and daily level. So now you should know what you need a ring on the cash register to keep your business afloat. And having these numbers handy, it's really helpful in alleviating stress and knowing exactly where you are with regard to sales revenues.
Now, your job is to keep adjusting the numbers in the spreadsheet to see what happens to the bottom lines if things get really expensive, sales are really slow, etc. Some people duplicate the spreadsheet and work best-case and worst-case scenarios. The spreadsheet is definitely the place to work out scenarios and adjust. You may discover that you need to cut expenses — and you can play with that here. And as your costs go from estimated to actual, you can revise the numbers in your spreadsheet.
All this futzing around, and now you have a pretty good operational model for the money going into and circulating around your business.
And, having done your numbers, you can pat yourself on the back and go forward in business with a much better understanding of how the actual business mechanics of your business will work. Nice work, business owner!