The first step in beginning a new business is to understand the cost of getting started and getting to break-even.
by Sherron Lumley.
“It’s exciting to start my own business because it’s taken me a long time to figure out what I really want to do,” says Renee Fisher, who recently launched an event-planning business in Portland, Oregon. “I used to put on parties when I was a little girl,” she says, “and I enjoyed it and people noticed I was good at it.” With background experience in organizing bridal shows, this is the moment Pull-Quote.pngshe has been waiting for. For her and for thousands of other entrepreneurs, forming a new business is one of the most exciting experiences of a lifetime.
A business needs passion, capital, and time to succeed, but deciding whether a business idea will fly starts with a hard look at start-up costs and the amount of seed money needed to keep the business going until it makes a profit (the break-even point). It could be a lot or a little, depending on the business, the funds available, and the creative abilities of the entrepreneur.
Brandon Davis, founder of Precision Rail of Oregon, tackles break-even analysis regularly. “We absolutely have to do that,” he says, noting that beyond estimating start-up costs, such analysis is also important for the ongoing success of the company. Fully immersed in the details of his business, Davis can easily recite the basic expenses of his operation: “cost of materials, cost of labor, the rent on the building and fuel cost for the vehicles.”
Write a business plan and make more money faster
The amount of time it takes to get past the break-even point and start making a profit differs for every small business. However, according to research by the Kauffman Center for Entrepreneurship, the world’s largest foundation devoted to entrepreneurship, companies with written business plans have 50 percent greater sales growth and 12 percent higher gross profit margins than companies without plans.
Even for those who aren’t spreadsheet-friendly, the task isn’t that difficult. Just write down every imaginable expenditure pertaining to the business prior to opening and for at least the first three months of operation. The U.S. Small Business Administration (SBA) advises new business owners to calculate the costs for several months up to the full first year. In fact, some businesses will not turn the corner and start making a profit until year two or three and creating a business plan will help you to discover that. In performing a break-even analysis, there are three key areas to examine: the initial start-up expenses (the buy-in), the monthly fixed expenses (the nut), and the monthly variable expenses (the burn rate).
The Buy-in: pre-operational start-up expenses
One of the ways Davis cut costs initially was by building his own website, which he estimates saved him $5,000. However, in retrospect he says there were drawbacks to that strategy. “It would be worth the expense to have a website designed by professionals who understand search engine optimization,” he says, referring to the digital specialty that focuses on making sure a business appears toward the top of the results when online searches are performed. Getting good results may require spending money on professional services, and this should be considered in factoring start-up costs.
Among essential early expenses, one of the first costs to negotiate is technology, including the purchase of computers, software, and phones. Other pre-operational start-up expenses include marketing and advertising, inventory or raw materials, insurance, and the business license. Every business needs one or more federal, state, or local license to operate, according to the SBA. (To find out all the local regulatory requirements in your area, visit the SBA’s Business Licenses and Permits Search Tool, which provides an interactive platform for learning all the federal, state, and local permits, licenses and registrations needed to run a business.) In examining all these expenses, be sure you are not overspending. In The Small Business Start-Up Kit from the legal publisher Nolo, author Peri H. Pakroo counsels budding entrepreneurs to only buy what the business really needs. (For a free online worksheet for calculating basic start-up expenses, check out The Frugal Entrepreneur.)
The Nut: ongoing fixed expenses
After calculating pre-operational costs, estimating the nut means adding together the fixed overhead expenses that do not change from month to month. Location expenses (rent or lease costs), salaries, and insurance premiums make up the bulk of this category. Regardless of how much business is done, rent does not change, employees expect regular paychecks, and insurance must be covered. Anything that is a regular reoccurring fixed expense should be included in the nut.
So, how much for rent? First be sure you have correctly identified exactly what your business needs because costs differ depending on what the space includes. Consider the cost of rent, length of the lease, quality of the space, operational limitations (such as hours of operation), zoning restrictions, storage capacity, lighting, data lines, security, access, and parking. For a retail space, the history of previous tenants and the type of neighbors are important. Factors to consider when looking for manufacturing space include the number of loading docks, shipping facilities, waste disposal costs, and proximity to suppliers and distributors. For an office-based business, the appearance, layout, privacy, meeting rooms, mail and shipping capabilities, and kitchen areas of a potential space are of greater consequence.
Salaries are another example of fixed expenses that do not change with the volume of business. If at all possible, avoid the common error of many budding entrepreneurs who neglect to pay themselves adequately. Just as insufficient cash flow can often spell the end of a small business, so too can being unable to pay your personal bills.
Finally, there is the increasingly large share of the nut taken up by insurance, most notably health insurance, which becomes more and more burdensome for small businesses every year. Other types of insurance you may need to secure for your business or its employees are dental, vision, life/disability, fire, loss/theft, business interruption, and malpractice. Make sure you carefully analyze the costs associated with each.
The Burn Rate: variable expenses
The burn rate is how much money is needed each month to meet variable expenses that change, depending on sales. Items in this category include cost of materials (inventory and/or raw materials), equipment replacement, project-based or seasonal labor, utilities, and delivery. For example, when Davis travels to meet clients or do railing installations, he burns fuel to get there. The more sales he has, the more gas he will burn. A literal example of the burn rate, this is an expense that is directly tied to sales volume.
Calculating variable expenses for a start-up requires some research to do accurately, and any expenses associated with doing so are tax deductible. Other tax deductible business start-up costs include the following from the Internal Revenue Service website:
Business analyses of potential markets, products, labor supply, transportation facilities, etc.
Advertisements for the opening of the business.
Salaries and wages for employees who are being trained and their instructors.
Travel and other necessary costs for securing prospective distributors, suppliers, or customers.
Salaries and fees for executives and consultants, or for similar professional services.
Birthing the Elephant, by Karin Abarbanel and Bruce Freeman
Business Plans Kit for Dummies, by Steven Peterson, PhD, Peter E. Jaret and Barbara Findlay Schenck
Ladies Who Launch, by Victoria Colligan and Beth Schoenfeldt
Six-Week Start-Up, by Rhonda Abrams
The Small Business Start-Up Kit, a Step-by-Step Legal Guide, by Peri H. Pakroo, J.D.
Renee Smith Fisher, owner
Renee Fisher Event Planning, Portland, OR
Brandon Davis, founder
Precision Rail of Oregon, Gresham, OR
IRS.gov: “Business Startup Costs”
Kauffman Center for Entrepreneurial Leadership:
Kauffman Index of Entrepreneurial Activity:
SBA.gov: “Business Licenses and Permits Search Tool”
SBA.gov: “Estimating Startup Costs”
SBA.gov: “Writing a Business Plan”
The Frugal Entrepreneur, Free Business Forms and Templates: