What an entrepreneur must know about determining startup costs in the
context of startup venture
tart-up costs play a vital role in the new business developments. They could
be the 70% of the expenses in the first year depending on the scale of the
venture. Unfortunately, start-up costs are those fixed costs which would be
spent even before the business is on Day 0. Below given are few categories under
which the entrepreneur needs to consider for the costs involved wherever applicable
to their business. Post understanding the financials in terms of cost, a decision can
be taken on the debt and equity and on the revenue to cover such expenses
including the break even period.
1. Land / Building / Construction costs – Depending on the type of business,
one must consider the cost of land involved for renting, purchasing or leasing.
At times, in addition to the land cost comes the demolishing of an old building
and building a new one in place of it. One could consider only the latter if
applicable to their business. If the initial costs of acquiring is too costly, renting
or even leasing is a much safer and feasible option.
2. Registration of firm – Legal proceedings with regard to registration of firm
with the concerned authority is a must when starting a new business.
Registration is not mandatory at times, but is advised to do so to grant the firm
as a legal entity. The firm cannot take any legal action until and unless it is
registered. Registration could be of the firm as well as certain other amenities
extended by it. Certain goods and services need to be registered for a TIN No.
in India. Certain not for profit organizations or organizations who extend tax
benefits to those donating need to register for a tax benefit no. too.
3. Office assets and furniture – Every business irrespective of product or
service industry requires certain fixed assets or furniture to begin with. This
infrastructure could also occasionally be used from the personal belongings if
working from home. Irrespective of the business and the kind of asset, the
usage or the cost has to be measured and an estimate has to be allocated to
be added in the books of accounts against expenses. While incorporating the
cost of the fixed assets, the depreciation format has to be decided in the
beginning for understanding purpose though it can be altered before the close
of the books of the year.
4. Cost of raw materials – Depending on the type of business, the raw material
need to be accounted for. To start with, a weekly or a monthly stock has to be
in hand till business starts shaping up and each loop hole is closed. The initial
raw material is to be decided with a lot of analysis as ordering too much would
block the capital from the beginning itself which could be put to better use.
Also ordering too little can call for trouble if the customer does not find his
specific product in the initial stages itself. An estimate demand needs to be
valued and an underestimated sales figure has to be used. Various methods
on demand forecasting can be used to finalize the amount to be accounted.
5. Cost of man power – Unskilled labour, skilled labour, managerial level,
executive level, third party members, part time workers, full time workers, etc.
Labour comes in many forms. As per the demand of the business, the
appropriate labour has to be selected and their payroll needs to be accounted
for. Even their training cost if applicable before starting the business, needs to
be incorporated in the start up costs. Ideally it is advisable to start with
minimum labour to ensure each one has enough work to do and the
entrepreneur also has enough responsibilities so that he realizes the roles and
can take better decisions in the long run. This would also help in saving costs.
6. Cost of technology – Only few business need to worry about this aspect.
The entrepreneur needs to trade off between labour intensive and a
technology intensive job profile. The higher the complexity of technology, the
higher the costs involved. Technology also needs to be checked for its IP and
other legal issues related to the kind of technology which can eat up the cost.
7. Offers and schemes – A very common marketing strategy at the start of a
venture is offers, schemes, etc to attract new customers to gain awareness.
These schemes are an expense to you as they would have been possible
revenue generating areas which for the interest of tapping initial customers
are being sacrificed. It is essential for the business to cover up these costs
8. Pre-Launch cost – This is a cost which is treated as a marketing cost. Before
the launch of the product / business / venture, awareness needs to be created
and a fortune is spent on doing this. Brochures, advertisements in different
mediums, parties, etc all would fall under this category. As this plays a vital
role in creating your business, sometimes the fortune spent here is
acceptable, though it can vary on the perspective of the entrepreneur. One
needs a lot of guts to spend this even before realizing a single penny.
9. Overhead expenses – As soon as the business is up and running, in addition
to the above costs, there would be overheads in terms of telephone and
electricity bills. Transportation costs, and other related stuff. Though it seems
to be trivial, sometimes this would end up as an enormous number. That could
happen if the start up costs were not thought in detail.
10. Salary of the entrepreneur – This is a debatable expense and it is the
discretion of the individual if this has to be charged or not. It is very rare that
the business would do profits immediately from Year 1 and 2. Therefore, until
the firms do not generate profits, owners might get very negligible amounts
from their business for their time and efforts spent in it.
11. Contracts and tie ups – It’s very rare that a business runs in isolation or else
self sufficient of everything. It has to get associated with vendors,
associations, third party contracts for outsourcing certain tasks, etc. The fees
and charges regarding the same are debited even before the start of
business. Normally these are per annum charges and therefore would be
advanced payments in many cases.
12. Working Capital – Though working capital will be generated as business
starts and is picked up over a period of time, it is essential for the business to
pay out daily expenses for the initial period. This would stabilize over a period
of 3-6 months and therefore, firms should be liquid enough to pay back these
expenses. Failing to do so will create enough trouble to crash land the
business even before it takes off and stabilizes.
13. Financing – At the end of finalizing the costs and pricing and the revenue and
profit model, it is now a call of the entrepreneur to decide on how to finance
this out. Not all individuals are born with silver or golden spoons. So that is the
point when they approach the other angel investors or venture capitalist.
Either it could be self financed, or it can be sourced by a bank, Though it is
difficult for a bank to finance you without financial security, it is not sensible to
avail business loans etc as there is no security available with the bank to lend
money in exchange for.
14. Returns – After forecasting the expenses, the most critical aspect of financial
analysis arrives. The fixed costs first need to be written off and pricing models
can be framed to ensure returns over a longer run. The margins need to be
zeroed upon and the entire pricing model needs to be fixed. Only based on
the kind of sales that are expected to be generated, the pricing can be
15. Tax – Tax is evaded in many countries and also tax benefits are available for
organizations. Entrepreneurs must look into these details if necessary. If not,
he/she should be aware of the tax slabs applicable to their business and make
a provision for the same. Not necessarily the first year would involve tax if the
firm is suffering operational losses, but still it is extremely important to
understand for every rupee earned, how much is the tax to the governments,
and how much is left over with you to retain or take back from the
16. Petty Cash – This could be included in the miscellaneous expenses at times,
but depending on the kind of business, petty cash is provided for separately at
times. This category is for the daily expenses on certain photocopies, snack
items, etc that do not have a significant category always.
17. Profit margins – Margins need to be decided based on the position of the
product in the market and also the competitors’ strategies. Too high a profit
margin would hike the price letting the competitor win over you due to pricing
and too low could make the customers feel an inferior quality sold by you.
Therefore, the right pricing and complimented by the right marketing, it would
play a vital role in attracting the customer.
Irrespective of all the measurable items for costing, two things which cannot be
measured and should not be measured is the time and effort behind putting the
business together. At the time of taking decision for the business, the entrepreneur
makes a trade off by measuring the opportunity cost of spending time on this project
or some other alternative. This can be treated as sunk costs or investments which
would pay off in the long run.
With every business, the categories and sub-categories of these start-up costs would
differ. As a thumb rule it is always better to over-estimate the expenses and under
estimate the revenues. The total of all these expenses would be the expenses of the
first year and the firm can work on a pricing model which could at least cover all the
start up and the fixed costs involved while running the business. With the theory of
economies of scale, as business grows the variable costs would reduce and the fixed
costs would get divided among the components and profits would be generated. Post
that happens; salary and reserves can be considered which would be used for the
larger good of the organization.
The above categories can be calculated through simple online calculators available.
Also it would be of great help to the entrepreneur to understand his cash flow over
the years and therefore it is advised to have a three year forecasted cash flow based
on the assumptions made earlier. This would enable the entrepreneur to understand
if he/she is cash rich or not irrespective of the profits or losses made. Cash in hand
plays a psychological role to motivate the entrepreneur to continue over the long run.
No entrepreneur can forecast till the last detail, but all assumptions if made on logical
understanding and if required scientific tools, it would prove successful for the
organization, individual and the economy on the long run.
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