Why would anyone want to start up their own business? Within the first eighteen months over half of small businesses fail. Still, the people who have the guts or are crazy enough to start their own businesses wouldn’t have it any other way. Some just need the freedom. Others believe that they can do it better than the next guy. And most have supreme confidence in their abilities, believing that they can do anything that they set their minds to.
My hat’s off to anyone who goes his own way. Unfortunately, the statistics indicate that even with a great business idea along with a positive mental attitude and core competency in the technology of the business, success is not assured.
Without good financial planning a new business can be doomed before it is up and running. Compiling a financial worksheet will give you a good idea of how much money you will need when you open your doors for business. Poor planning and insufficient funding is a major reason that new businesses fail. As Napoleon rightfully observed, the battle is won or lost before the first shot is ever fired.
For Napoleon, the key to success was good planning. And based on what he said, you would think that calculating startup costs and formulating a business plan is a simple, straightforward process. It just takes some time. Well, it’s not as easy as it looks. And you also need some flexibility in your planning. Here’s why.
When it comes to a business plan, all of your theorizing may not survive reality once you are open for business. That doesn’t mean that you shouldn’t do any planning. Just remember what Eisenhower said: “Plans are nothing; planning is everything.” No, Ike wasn’t drinking at the time he said it. And it’s not a Zen riddle either. Ike understood the time-tested maxim that no plan withstood first contact with the enemy. Once the battle began, you had to change the plan based on changing events.
The same holds true in business. Once you are open for business, your plan will need to change to meet the requirements of the market. As you are compiling your startup costs, you should write down everything that you think you will need. You will probably rack your brain, and come up with a pretty comprehensive list. No matter how hard you try, the fickle finger of fate will throw you a curve. All of a sudden, you will encounter trials, tribulations and expenses that you never imagined.
If you are still wondering why write a plan in the first place, as imperfect as it may be, having a plan is a whole lot better than not having one. As you formulate your financial plan, here are some areas it should cover:
- Startup Expenses (In the startup phase of your business, you are allowed to write off a portion of your startup expenses. That’s why you will need to carefully record all of these expenses.)
- Legal fees.
- Accounting costs.
- State incorporation fees.
- Business permits.
- Initial payroll expense.
- Sales and marketing expenses. (This includes presentation materials as well as logo design, website development, brochures, business cards.)
- Office supplies.
- Office equipment (computers, copiers, etc. Ask your account what portion of equipment is allowed as an expense, if any).
- Office furniture (desks, chairs, tables, partitions, phones).
- Shop equipment.
III. Financing (Cash on hand; how much money you have in the bank).
- Investments (What you or others put into the business).
The financial information that you compile should play an important role as you construct of your business plan. This information will also provide you with a good idea about how much cash you will need to get your business started. Your cash balance consists of all the money that you have raised as an investment along with all of the money that you have borrowed minus all of your startup expenses and your assets.
“The major reasons why most businesses fail are an improper understanding of cash flow as well as mismanagement and inadequate planning of working capital,” says Tim Reimer, Controller for Nekoosa Holdings, Inc. “Covering fixed costs is the easy part of the financial equation. But planning inventory purchases and expected inventory turns along with expected payment terms are critical to the success of a fledgling business. No one wants their money tied up in inventory or receivables for too long.”
Make sure that you carefully track all of the starting expenses that you incur prior to opening day and segregate them from any of the shop and administrative expenses incurred after you open the doors. Do not record the startup costs as expenses on your profit and loss (income) statement. Also, you cannot charge any of your assets as expenses. Assets and expenses are two different animals. Expenses you can write off. In other words, you can deduct them from taxable income. Assets, on the other hand, are not deductible, but can be depreciable.
“Startup costs and assets do have some tax deductible value, but are treated very differently than expenses,” says Reimer. “You may be able to deduct or depreciate all of the expense in the first year.” The rules covering how much you can deduct and when you can take the deduction varies depending on the total amount of startup costs. For businesses with startup costs of $50,000 or less, the first-year deduction can be as much as $5,000. Because IRS rules can be a little tricky and change from year to year, be sure to consult with your accountant or tax advisor regarding any startup deductions.
“Fixed assets, such as your shop equipment, are not regarded as startup expenses but can be written off through depreciation,” Reimer says. “The depreciable tax value of a particular asset will be treated and depreciated differently depending on the expected life of the asset.”
In addition to calculating the one-time startup costs, you should also list the recurring fixed monthly expenses. Fixed costs are exactly what you may think they sound like. They don’t change. With fixed costs what you see is what you get, month in and month out. Until you get cash coming in from sales, the first few months will be tough, so you had better have enough in your checking to cover those fixed expenses. These fixed costs for your shop might include:
- Employee wages
- Utilities (gas, electric, water, sewer)
- Shipping costs
- Phone expense
Understanding your startup costs as well as your fixed monthly expenses is also critical in determining your breakeven point and developing your sales forecast. With thorough planning, you will improve your odds of success as you pursue your new business endeavor.