Tuesday, February 14, 2012

Small Business and Entrepreneurship - To Startup or Not To Startup Part III - Costs

"If you would know the value of money, go and try to borrow some." - Benjamin Franklin

"Dogs have no money. Isn't that amazing? They're broke their entire lives. But they get through. You know why dogs have no money? No Pockets." - Jerry Seinfeld

Happy Valentines Day! In the spirit of Valentines Day we've decided to continue our Small Business and Entrepreneurship series with a look at determining the costs of starting a new business. :-)

As we continue our series on examining the decision to start a new business we want to note that while we will cover many topics there is no specific order in which any of this work needs to be conducted. It may be that in researching your target customers you develop a better "idea" and go back to refine your prospective product. Perhaps you complete a set of financial figures only to determine in other research a new set of costs you had not previously considered. The point is the whole work, as anything in life, can be an ever-changing piece. Knowing when to say "enough is enough I've done enough research" may be just as important as understanding anything else in this process.

In our next few articles we will examine financial projections. We will begin here with examining costs, and in the coming weeks we will look at projecting sales, analyzing our results, determining cash needs and then we'll begin to get into marketing with a look at product pricing.

Financial projections consist of two major parts - revenues and costs. When begining to think about starting a new business it is often helpful to do a quick calculation - "I think I can make $X.XX and it will cost $X.XX" (hopefully more like $X,XXX,XXX.XX for the former and $X.XX for the latter of course), but at some point it will be necessary to get into a litter more detail.

We can begin by simply making a list of every cost we can possibly think of. Of course, businesses vary widely in their nature and for that reason no two lists of costs will look the same. There is an equally wide variety of ways to categorize or group these costs together when constructing your financial projections. But for this "brainstorming" type of exercise it can be helpful to look at potential costs in a systematic, organized manner. In other words, to "brainstorm" by category, something like:

Pre-Launch Costs - Are you going to need a functioning prototype of a product prior to launch? Sometimes beginning companies can arrange orders with customers prior to launch (after confirming with manufacturers what it will take to produce a product). Sometimes companies can even secure advanced orders and get cash in house before beginning production, but this is not always the case. Does any additional research or other product development need to be conducted prior to launch? You may not be completely certain your product will work, does any testing need to be conducted first?

Up-front Costs - These up front charges are more specific to operations than the pre-launch "development" type costs discussed above. Will you need manufacturing or other types of equipment? If you need an office or warehouse space, what about rent and security deposits? Also consider office supplies, office equipment, state Business and licensing fees? Are there any other legal or licensing fees for establishing your type of business?

Production costs - What is it going to take to actually produce your product or service? What sort of materials or training will you need? At this point do you believe you will be manufacturing the product yourself or contracting with another company? What about packaging for your product? If this is a service what materials do the service providers consume?

Shipping - Does this item need to be shipped? Do you know what the weight and dimensions of a packaged product may be? What geographical range do you think your customers will inhabit and therefore, what would be the range of your shipping costs to reach them?

Operations Costs - This would be things like monthly rent, phones, utilities, internet, marketing costs, travel, and office supplies, but also make sure to consider insurance. How many employees do you think you will have? How much would it cost to cover workman's compensation insurance? What about general liability and/or product liability insurance?

Employees and Labor - How many people will you need for production of your product or service? What about for support, management, accounting, sales and marketing? What are the current market rates for those types of employees? If you do have employees what about their payroll processing and benefits?

After compiling a good list of potential expenses it is time to come up with some figures for them. As the saying goes "garbage in garbage out"; if the estimated figures you determine for your individual costs are based on nothing, then the results of your financial projections will be just as meaningless. This can be a time-consuming process but it is an important one. Collect quotes for each of the items in your list. People often remark that when starting a business everything "takes twice as long and costs twice as much" as what is expected. The goal here is to come up with as accurate a picture as possible of what you are likely to face. After you start your business if some things come out more expensive than you expected, that is ok and to be expected. However, if everything costs twice as much as you expected you could be in trouble!

Determining costs is an important part of the process of deciding whether or not to start a business. It is important to try to think of everything you can. Many overlook things like general liability, workers compensation or product liability insurance, legal fees, business establishment costs and licensing fees. One large missed expense, or the combined impact of many small missed expense, can seriously hurt a business. Next week we'll take a look at what should (hopefully) be a happier subject, sales!

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