Lots of variables come into play when attempting to figure out how much money you will need to start your own company.
Why is it important to identify those variable? Because the number one reason new businesses fail is that the person starting the business was not thorough enough in their information gathering stage and as a result, drastically underestimated the amount of cash it would take to run the business.
Successful business owners need to be optimists but being overly optimistic when determining how much money you are going to need to start and run the company is not a good thing. People wanting to start their own business tend to see the world through rose colored glasses. They see sales starting out strong and getting stronger, they see profits rolling in early in the start up and growing every month from then on. I could go on, but you see what's going on here.
If you start out with an aggressive overly optimistic view or prediction of how well your new company will do, then there is a very good chance that it will take more money than you budgeted. Sometimes a lot more money. People often think that if they are off by a little bit then that's okay, but it isn't. If you don't have the money to fulfill an order, then the order gets cancelled along with all the profit you were anticipating from the sale.
If you under estimate the amount of money you need by just a little bit and in the end you can't come up with that little bit of money, then you are out of business. For example, if you make a big sale but don't have the money to order the product you have sold, then you are out of business. I have seen companies "sell themselves broke". You wouldn't think it was possible but it isn't that hard to do. A company that spends nearly all of their start up money in advertising must have money set aside to buy the inventory needed to fulfill orders. Too many times I have seen companies take 10-20% down payments on sales, then spend that money on sales commissions and in the end not be able to fill the customers orders. It's easier than you think to do and if it happens to you, your new company is out of business.
So how much money do you need?
The first thing you need to do is NOT think about the company. The first thing you need to know is how much money you will need to live on until the company turns profitable. That means an honest assessment of your living expenses. You must know the bare minimum your family will need each and every month until the company can begin contributing to those expenses. Mentally this is a very tough thing for people to do. There is a tendency to say things like "If things get tough, we will just cut back". With that attitude, you are almost certain to fail. You can't put the future of your comany on something as vague as 'cut back'. You have to know the exact number you need every month. Just to be safe, you should run two sets of numbers, the 'what I think will happen' and the 'worst case scenario' too. That's a smart thing to do. If your business plan shows the company will be profitable in 12 months, then run a worst case scenario. It may show 18 months to profitability. Be prepared for your worse case scenario.
Now, here is common problem with new owners. They do not put the money for their projected living expenses aside in a totally separate account. If your worst case scenario shows you will need 9 months of expenses, then you should have 9 months expenses set aside in a separate account earmarked just for living expenses. Why a separate account? Because if you underestimate the amount of money you need to start your business then you do not want to spend your living expenses on the company. If it happens, it will be tempting but you absolutely must not use your living expenses account for anything else.
At this point, a lot people are going to say "No way. If I wait until I save that much money, I'll never go into business for myself". If you are thinking that, then you are not prepared to go into business for yourself and you SHOULD NOT even try. If you don't have the discipline to execute this sort of plan, then you most likely don't have the discipline necessary to start and grow a business either. That's probably not something you will hear from your family or friends but I am neither of those. I'm just trying to get you to open your eyes.
If you are still reading then I'll; assume you agree that you need to set aside your living expenses. Next we move on to the actual money it will take to set up/start your business. This is not the cost of running the business, but just starting the business. There are a lot of one time expenses which you will incur when starting a business and these are totally different from the expenses of running a business.
Here is a short list of "Start Up Expense Items" you may have to consider. This is not all inclusive, and is designed to hopefully get you to really start thinking.
Office Supplies
Deposits - telephone, utilities, city permits, etc.
Insurance - Business and Property as well as Liability and possibly Worker Compensation Insurance
Signage - A simple neon sign on the front of your building can cost thousands of dollars.
Licenses and Permits - There may be special permits or licenses required for your industry. These can be very expensive if your business is highly regulated at the state or federal level.
Furniture and Fixtures - Office furniture, counters, displays, office equipment like fax machines, computers and printers.
Equipment Installation - If your business requires specialized equipment or is a highly regulated industry, then you may be required to have all equipment installed by 'licensed companies".
Facility Lease Payments - For a new company, you can expect to have to personally guarantee all leases as well as have to make payments in advance.
Professional Fees - Fees related to the legal entity you elect will vary. A simple "Assumed Name" or DBA (Doing Business As) is the cheapest but may not be the right choice for you. You will need some legal advice on the proper way to go and it will not be cheap. You might also like to meet with an accountant (CPA) to assist you in setting up your bookkeeping system.
Cash - this is the amount of daily cash you will need to put in your cash registers to get started.
Employee Cost - in some cases, you may want to hire an employee to help you with the start up activities. If this is the case then budget for their salary and federal taxes.
Unexpected Expenses - because no list is complete, you should budget an amount for 'things I forgot' or 'things that cost more than I thought they would'. A good number for this category is to total up all the other expenses and then take 15% of the total for this. The number may seem high but it's better to plan on the fiscal conservative side.
Advertising - Some people think it's strange to put a advertising category in start up expenses but think about it. You don't want to wait until you have opened the doors on your new business to start advertising. You want your initial advertising timed to get people in the door from the very first day. Some advertising mediums require up to 60-90 days advance notice. This is especially true if you are considering any magazine advertising. Check with the companies you plan on advertising with to make sure you plan according to their schedule.
Conclusion:
All of the expenses outlined in this article are needed before you ever even open the doors of your new business. Take your time and prepare thoroughly. You don't want any unpleasant surprises when working to get the doors open on your new business.
In my next article, I will be discussing the major categories of the expenses of actually running the business. Those are more of a recurring nature.
Plan wisely.
