How to Estimate Business Startup Costs and What It Covers

Starting a business involves much more than just setting up an office or choosing furnishings. It demands careful financial planning and precise accounting, particularly in the initial stages.

Many new businesses make the mistake of not properly estimating and budgeting for startup costs, relying too much on a sudden influx of customers. This approach often leads to poor results and even the business's failure. A solid financial plan is key not only for managing startup costs but also for building a foundation for your venture's future growth.

Understanding Common Business Startup Costs

Startup costs are the expenses a new business faces during its creation. Unfortunately, starting a business with no money is challenging and not an option for most businesses, which will require capital to start operations. Each business is unique and thus incurs different types of startup costs depending on its nature of operations.

For example, online businesses, such as e-commerce websites, often have lower initial capital requirements than brick-and-mortar businesses, such as restaurants. This difference in startup costs may stem from online businesses needing less physical space, fewer furnishings, and often fewer staff compared to brick-and-mortar operations.

Despite these differences, several expenses are common across most types of businesses. These typically include costs related to legal or attorney fees, licensing, initial inventory, market research, and marketing efforts to launch the brand.

The Business Plan

Creating a business plan is crucial for starting a business as it provides a detailed roadmap and prompts careful consideration of various startup costs. Underestimating these expenses can lead to an inflated expectation of net profit, which can be detrimental for a small business owner. Hiring a consulting firm or a business plan writer to assist with creating a business plan can cost between $1,000 and $5,000 or more. The final price often depends on the complexity and length of the plan.

Research Expenses

Before launching a business, it's crucial to thoroughly research the industry and target consumer demographics. Some business owners opt to hire market research firms for this purpose.

Hiring a market research firm is essential for companies wanting to excel in competitive markets. These firms offer key insights into customer preferences and industry trends, using both qualitative and quantitative data to inform strategies ranging from product development to marketing. Their analysis helps businesses make informed decisions and identifies potential risks and opportunities.

For business owners who choose to follow this route, the expense of hiring these experts must be included in the business plan.

Borrowing Costs

Starting up any kind of business requires an infusion of capital. There are two ways to acquire capital for a business: equity financing and debt financing. Equity financing usually entails the issuance of stock, meaning the company offers shares of its ownership to investors in exchange for funds. However, this doesn't apply to most small businesses, which are proprietorships and don't issue stock.

For small business owners, the most likely source of financing is debt in the form of a small business loan. Business owners can often get loans from banks, savings institutions, and the U.S. Small Business Administration (SBA). Like any other loan, SBA business loans come with principal and interest payments that need to be carefully planned for when starting a business, as failing to make these payments can result in severe consequences.

Insurance, License, and Permit Fees

Many businesses are expected to submit to health inspections and authorizations to obtain certain business licenses and permits. Some businesses might require basic licenses while others need industry-specific permits.

Carrying insurance to cover your employees, customers, business assets, and yourself can help protect your personal assets from any liabilities that may arise. 

Technological Expenses

Technological expenses include the cost of a website, information systems, and software, including accounting and point of sale (POS) software, for a business. Some small business owners choose to outsource these functions to other companies to save on payroll and benefits.

Equipment and Supplies

Every business needs equipment and basic supplies, which are crucial components of startup costs. When planning these expenses, you must decide whether to lease or buy the equipment. 

The state of your finances will play a major part in this decision. Even with sufficient funds to purchase equipment outright, it might be more practical to lease initially, with the option to buy later, especially if other unavoidable expenses arise. However, it's important to remember that, regardless of the cash position, leasing isn't always the most beneficial option depending on the type of equipment and the lease terms.

Advertising and Promotion

A new company or startup business is unlikely to succeed without promoting itself. However, promoting a business entails much more than placing ads in a local newspaper.

It also includes marketing—everything a company does to attract clients to the business. Marketing has become such a science that any advantage is beneficial, so external dedicated marketing companies are most often hired.

Employee Expenses

Businesses planning to hire employees must plan for wages, salaries, and benefits, also known as the cost of labor. This includes not only direct payments but also any additional benefits that contribute to employee compensation packages, including health insurance, retirement plans, and bonuses.

Failure to adequately compensate employees can result in low morale, mutiny, and bad publicity, all of which can tarnish a company's reputation and be disastrous for the business.

Additional Startup Cost Considerations

Set aside some extra money for any overlooked or unexpected expenses. Most companies fail because they lack the cash to deal with unexpected problems during the business season.

It's important to note that the startup costs for a sole proprietorship differ from the startup costs for a partnership or corporation. Some additional costs a partnership might incur include the legal cost of drafting a partnership agreement and state registration fees.

Other costs that may apply more to a corporation include fees for filing articles of incorporation, bylaws, and terms of original stock certificates.

The Bottom Line

Understanding and planning for startup costs is crucial for any new business. These costs include pre-opening expenses, like market research and business plans, and post-opening expenses, such as marketing and employee salaries. Every business has unique costs, but common expenses often involve legal fees, permits, equipment, and technology.

Accurately estimating your startup costs is key for any new founder. Realistic figures can help secure funding from investors or banks and ensure smooth operations. Keeping detailed records from the start can also help you in financial planning and maximizing tax benefits.