Small business start-up costs.
There are many costs involved with starting and running a business. Don’t be among the many new owners who underestimate just how much money they’ll need.
When starting a business there are 3 types of costs to take into account:
- Start-up, set up, or establishment costs.
- Fixed Assets, resource or capacity costs.
- Cost of Sales and Operating Costs.
Starting your own business and bringing your great idea to life is often a time of great happiness, hope, fear, anxiety, frustration, panic and joy. There must be something in it though because about 300,000 new businesses are created in Australia each year. Sadly, many of them don’t make it through their first couple of years as they have underestimated how much financial investment it requires.
Many factors contribute to the success of a new business, including having a product or service that other people will pay for, pricing it correctly, producing it to the right standard, marketing it well, selling it in the right place at the right time, and having the money to last the distance.
This article addresses that last point … having the money to last the distance. There are many costs involved with starting and running a business however many new owners underestimate just how much money they’ll need. There are three main areas where costs are incurred.
1. Start-up, set up or establishment costs.
Whether you refer to them as start-up, set-up or establishment costs, these are generally one-off administrative type costs required to get the business up and running, and which are unlikely to recur. Examples are setting up your business legal structure, registration of your business name, registration with regulatory bodies, applying for your Australian Business Number, registering with the tax office, establishing your financial systems (e.g. merchants/new accounts) and your accountant and solicitor fees for helping you through this stage.
It’s a good idea to bear in mind here, that even though you’re trying to keep these costs to a minimum, it pays to think long-term and get set up correctly from the outset for the business outcomes you have planned. For example, it may be cheaper to set up as a partnership initially, but it will cost you more to disrupt that structure in the future if it’s not suitable for your rapidly growing business and profits.
Use whatever information sources you have available to you (e.g. accountant and solicitor) to forecast as accurately as possible what these costs may be and ensure you have the available resources to be able to pay them as and when you need to when bringing your new business to life.
2. Fixed Assets, resource or capacity costs.
Then there are the costs to acquire all the things that are needed to operate the business. Things such as:
- the premises from which you will operate,
- fitout of those premises (flooring, wiring, shelving, furnishings etc)
- motor vehicles or machinery,
- technology and software, and potentially
- goodwill, trademarks, or intellectual property.
These are the most common costs however this list is far from exhaustive. Many of these are commonly referred to as fixed assets. Some of these assets are quite costly and if you buy them outright, they can tie up a lot of money which can then no longer be used for the day-to-day operation of the business.
To minimise the amount of money you need to initially acquire these assets, you could:
- Hire them on short term rentals. This may be more expensive in the short term (from a profit perspective), but it allows you flexibility to grow at the pace of your business and minimise losses if things don’t go to plan. But look for a reliable hire company as it could be detrimental to your new business if the equipment is not available when you need it or breaks down on the job.
- Rent your premises on a long-term lease. This helps your cash flow by spreading out the payments; providing certainty of the payment amount; and confidence that the premises will be available when we need it. The downside? If things don’t go to plan you may need to keep paying rent until the end of the lease term or until a replacement tenant can be found.
- Borrow to purchase the assets. That is, take out a business loan, financial lease, equipment finance, or hire purchase to acquire the asset. This way the cost of the asset is spread out over the life of the asset via loan repayments, however, there are the added costs of interest and fees. Similar to a long-term lease, this has the downside of perhaps being locked into an unproductive/unnecessary asset and loan repayments.
Ultimately, you would look to find the right balance of equity investment, borrowing, and hire/rental costs to set your business up with the fixed assets it requires to operate effectively and efficiently and to provide you, the owner, with an acceptable level of risk and reward. It’s a good idea to build into your planning what maintenance these assets may need in the future, or when they may need to be replaced, as this can help with deciding how to fund their acquisition.
3. Cost of Sales and Operating Costs.
Cost of Sales, sometimes known as Cost of Goods Sold, are those costs directly related to the sale of your goods or services and generally include stock/inventory, direct freight, and direct wages. Management of these costs is critical to having a strong Gross Profit. The key to managing these costs is to only buy as much as you need – this includes staff time and skills as well as stock.
It’s therefore important to know:
- How long does it take from ordering your stock to when it arrives for use in the business?
- Do you have a value-add process? If so, how long is it before your goods are ready for sale?
- Is there a long lead time to a sale or is the customer decision-making process relatively uncomplicated and timely?
- How long does it take to do a job and what wages will need to be paid before you receive payment for the job?
- What is the right level of stock to be holding? And what other costs might be associated with that?
For example, your supplier may have minimum order quantities or bulk buy discounts which may be higher than your usual sales level, meaning that you then need to store this stock, potentially incurring storage charges. Consider quantity discounts or holding safety stock carefully as these additional costs may chew up your cash at a time when you need it for other purposes.
Operating costs include all the other ongoing costs you need to incur to operate. Things such as staff wages, superannuation, technology and communications, electricity, gas, water, insurances, fuel, maintenance, subscriptions, packaging, marketing/advertising, professional fees … the list seems endless. The key to managing these costs is firstly to ensure that they all contribute in one way or another to the achievement of the business’s goals; and secondly, that they’re being spent in the appropriate proportion.
It’s important as you’re starting out, that you forecast as accurately as possible how much these costs will be and what cash reserves you may need to have on hand to pay these until your sales start flowing through.
This is not an exhaustive list of start-up costs but a thought prompter to kick off your thinking. To give yourself a better chance of realising your business dream, develop a rigorous business plan that includes a profit plan and cash flow budget. Use your accountant, lawyer, peak industry bodies or other industry contacts to help you identify potential costs. Remember, if cash flow is going to be tight, implement tactics such as buying smaller quantities more often, or spreading your payments out through renting, leasing or long-term borrowing. Even if it costs you more money initially, the benefit of having extra cash available during your start-up phase will outweigh the cost in the long run.
This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness for the information to your own circumstances and, if necessary, seek appropriate professional advice. ©Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714.