Startup costs are necessary for launching a new business, and it’s essential to plan and account for them carefully since running out of money is the second biggest reason startups fail. However, entrepreneurs can prevent this from happening by creating a crystal clear picture of exactly how much money their company needs to survive and thrive.
In this article, we help you understand how startup costs work, what to expect and how to calculate them so that your new venture starts on the right foot.
What are Startup Costs?
Startup costs are the anticipated or actual expenses entrepreneurs need to start a business. Calculating business startup costs is vital for accounting, business planning, and tracking. A startup’s costs will vary according to the business entity, industry, location, and size.
For example, local retailers with a physical location have much different startup cost needs than those operating solely online. However, most businesses have similar startup costs, including pre-opening and post-opening expenses.
Example of Startup Costs
Seeing a real-world example can help us understand how more complicated or abstract concepts work. Here is an example of startup costs to better understand how they work:
- Sean has an extensive collection of fine crystals that he wants to sell online
- He acquired these crystals by purchasing unique stones over several years and valued at $90,000
- Sean already has plenty of inventory, but for how long and how will he sell them?
- He also knows that he needs to execute his marketing plan, which includes a website with terms and conditions and a privacy policy
- Based on projections, Sean believes he can sell $9,000 in crystals every month with $3,000 in startup costs
- However, he also knows he’ll run out of crystals within ten months of launching the site
- Sean must also plan for sourcing new products, including shipping costs and travel, but he doesn’t want to spend more than 33 percent of revenue on promotion
- He is creating his funding objectives for the next three years
- Sean needs around $3,000 per month or $108,000 in three years for startup costs
How Much Do Startups Usually Cost?
The cost for a startup drastically differs from company to company, and a microbusiness or home-based franchise can start around $2,000. However, the average cost of starting a small business, big or small, is about $31,000.
Avoid underestimating your expenses, and always keep the changes your business may face at the top of your mind. Overlooking startup costs is easy when focused on the bigger picture. Being a successful entrepreneur requires you to play both positions for the best possible outcome.
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How to Calculate Startup Costs
Many entrepreneurs have a closely held belief that startup costs are all about operating expenses. While these costs are vital, you need to consider them from a big picture perspective, too. Building a plan filled with milestones will also keep you on track for the next stage.
Here is a five-step process for calculating your startup’s costs:
Step 1. Set Your Milestones and Objectives
Beginning with the end in mind is an essential step for calculating startup costs. Look at where your company is currently at, and then think about where you’d like for it to be in the next three to five years.
Set financial objectives with milestones along the way that alert you to positive and negative progress so that you can make adjustments as needed. Your business plan should be a treasure trove of insight for this step.
Step 2. Create a Financial Roadmap
After reviewing your objectives, your next step is to create a financial roadmap. Try to anticipate how your business will change as you achieve each milestone set.
While your business’ startup costs may look different, here are a few examples of costs that you may incur:
- Business structure fees
- Consultants
- Equipment
- Furniture
- Insurance
- Inventory
- Marketing
- Payroll
- Rent/mortgage
- Shipping
- Supplies
- Taxes
- Travel
- Utilities
- Website
Account for these items, line by line and phase by phase. As you achieve milestones, such as moving from the pre-launch to the post-launch stage, some of these costs may change over time. Consider how you can partner with collaborators to enhance your results or reduce costs.
Step 3. Start Looking at Funding
Now that you know exactly how much money you need, it’s time to determine your funding approach. Can you bootstrap your efforts, or do you need outside help? The best way to answer this question is by calculating your startup’s burn rate, which is the amount of capital your company will need each month.
There are several ways to calculate your burn rate, such as using pro forma template data. However, this article assumes that you’re a brand new startup without any funding whatsoever. So, what you’ll do in this situation is take your anticipated expenses for each year and divide it by 12 to get annual projections.
For example, let’s say you anticipate spending $100,000 in the first year and $50,000 for the second year, then your burn rates are roughly $8,333 and $4,167, respectively. These numbers will tell you if you need to seek additional funding from outside investors, such as venture capitalists, angel investors, and banks.
Step 4. Set Funding Goals
Depending upon your results from the preceding steps, there are several ways you can approach funding. From convertible debt to SAFE notes to family and friends, set and structure your funding goals so that they’re sensible for your situation.
Your burn rate and total expenses are merely a baseline that establishes how much money you will need. Think about what you’ll need for a cushion, but don’t go overboard since too much funding can be a bad thing at the wrong time.
Step 5. Use Funding to Balance Milestones
When you know how much money you need to hit your primary objectives, it’s time to start thinking about what you’ll need to hit your milestones in between. You’ll need to consistently review these two points so that you hit your funding and business goals as expected.
You can also check out this article to learn more about calculating startups costs.
How Do Startup Costs Impact Taxes?
The Internal Revenue Service (IRS) allows startups to deduct some or all of their startup costs on income tax returns for the year they launched their business. However, this amount also depends on the amount spent and amortization. If you spend less than $50,000, then you can deduct $5,000 from your taxes immediately.
However, if you spend over $50,000, the deduction decreases by $1 for every dollar over $50,000 spent. You can also amortize assets by writing them off over time. So, if you purchase a $5,000 server and amortize it over five years, then you can write off $1,000 for each year in service.
For more information about startup costs and taxes, this web page may be helpful.
You cannot deduct startup costs from taxes, including research, development, taxes, depreciation, and asset transfers, and these costs don’t qualify for amortization or deduction.
If you have questions about how startup costs impact your business, speak with a lawyer for a startup in your state. They can help you develop your projections and install the necessary legal documents to protect your new business.
