How to Estimate Startup Costs

One of the reasons having a business plan is a good first step for starting a business is to answer the fundamental, and critical question of how much money it will take to get the venture started. I've had two good friends who, with different businesses in different years, started strong but failed because they ran out of resources.

In the first case, additional funding might have been available had my friend planned better and applied for a larger loan. But when things went bad, his credit suffered and he wasn't able to ask the bank for more money. In the case of my second friend, she probably would have planned to use fewer resources and ramped up more successfully if she had a more detailed estimate of her startup costs.

The point is, having an educated idea about startup costs can benefit your business more than not having a plan at all, and facing more unforeseen surprises. The key is to look at your business expenses as individual components.

You can calculate starting costs by making three simple lists, a few educated guesses and then adding them all up.

Related: Starting Costs Calculator

List spending on assets. Your business assets are the things you need to use in your business over the long term. For example, if you're starting a brick-and-mortar store, that might include items such as shelves, tables, a cash register and so on. A graphic artist might need specialized printers and a drafting board, among other things.

If you're either making or selling products, think about the inventory you'll need to have at the start. The easiest example is the books a bookstore needs to stock its shelves or the raw materials a manufacturer might need to start assembling a product. If you're starting a service business -- meaning you don't make or sell products -- then don't worry about inventory. You can skip this step.

All of these items make up your starting assets. While you might also think the money you have in the bank is an asset to list here, we're going to save that for another list later on.

Related: Two Weeks to Startup: Day 3. Calculating Startup Costs

For every item on this list, make an educated guess of what the amount of expense will be. If you can't estimate the price for an item off the top of your head then do some research. For instance, call real estate agents to inquire about rental space and prices. Contact insurance brokers to ask about insurance plans and prices.

One important note: Although computers and office equipment should logically be included on this list, the federal tax code allows us to deduct their cost from our taxable income as expenses, so most accountants recommend calling them expenses, not assets. We'll get to these in the next list.

List spending on expenses. Not everything you purchase is an asset. You also spend money on expenses. For example, it costs money to set up a legal corporation, an LLC or a partnership. The money you spend to build your website, the costs of fixing up your office and the salaries you pay employees to help you set up are also examples of expenses.

And, because of the special tax treatment I mentioned earlier, include expenses for computers and other office equipment on this list.

Now, add up your starting assets and your starting expenses to calculate most of your starting costs.

Determine how much money you'll need to get started. The final piece of the puzzle is knowing how much cash you'll need to have in the bank for the early months while your startup is ramping up and not generating enough sales to cover costs and expenses.

There are a number of theories on how to do this. Some people say you need enough to cover six months of expenses. Others say a year. But in my experience, it's usually not that easy.

My suggestion is to estimate your first 12 months of sales, costs of those sales and expenses. To help create a sales forecast, you might want to reference one of my previous columns. You might also consider reading the section on creating an expense budget from my Plan-As-You-Go Business Plan book.

Related: Startup Costs Worksheets (Form)

What you should end up with is a list of 12 months with estimated sales, costs and expenses for each month. Subtract the costs and expenses from the sales for each month, and the result should show you whether you're short of cash. You'll be able to tell from that spreadsheet how many months it takes to start breaking even and how much money you're missing. That's essentially what you need to have as starting cash.

And if you were hesitant about putting together a business plan, you're already well on your way after calculating the numbers here.