It’s hard to estimate expenses for a startup business. Yet those numbers are critical to your success. They are also necessary to convince investors or bankers that your startup will be profitable.
First, a couple of assumptions. I presume you have identified all major expenses. Use a checklist of expense categories like those on the score.org website, so you don’t miss anything. And while some costs are fixed, many expenses depend on your sales projections. We’ll assume you start with reasonable projections for the first two or three years and now just need to identify the related business costs.
Let’s talk about three ways to make the numbers reasonable and believable: competitive quotes, breakdown/roll up, and industry sources. Finally we’ll take a quick look at “free” activities.
1. Competitive Quotes
Researching quotes for outside products and services is THE best way to estimate your costs. Examples of “researchable” costs are rents, build-outs of space, equipment, insurance coverage, attorney fees, outside marketing, PR, software consultants, raw materials, shipping costs, even internet and phone services.
I strongly suggest three competitive quotes for large costs. You will learn about features, and more importantly about exclusions, in the process. The first estimation method, then, is to get competitive quotes.
2. Break It Down and Roll It Up
The second method is to estimate the pieces and then build up your costs. I call this “Break It Down and Roll It Up.” Let’s take travel. You might be tempted to pull $1,000 out of the air for travel. But we can put together a simple formula. For example, you might have three people taking two cabs per week with an average charge of $20. If all three work 50 business weeks a year, you project $6,000 for travel expenses.
This method is scalable, up and down. If you have more or fewer salespeople, you can recompute the expense. Use the same method for shipping and other variable costs. The second method is to “Break It Down and Roll It Up.”
3. Industry Feedback
You network, don’t you? Attend trade and industry meetings, exchange business cards? Send an email to friendly contacts and ask a simple question, like “what percentage of revenues does a successful retail store spend on sales and marketing?” Or buy dinner for somebody in the industry, but outside your market area, and ask specific questions.
If you’re a member of Linkedin or online business networks, post a query in their forums. You’ll be surprised, but consultants and experts are hanging around to answer your questions, in hopes of building relationships and getting your business down the road.
Franchise documents are also a good source of industry estimates if franchisers are in your niche. Even if you aren’t buying a franchise, you can request franchise materials and see what costs and cost ratios they project.
Industry ratios are also available, although percentages vary with region and business strategy. (See links at end of post.) At SCORE, we see many clients selling retail fashion accessories. So I checked BizStats.com for sample P&L ratios and found “corporate clothing accessory stores.” Cost of sales are 51% of gross sales, rent are 7% and sales and admin combined are 12%. Remember that these are ratios from ongoing businesses, so percentages are most relevant for years two and three of your projections. Startup year percentages may be different. Trade associations and publications also have industry data.
Estimation method three, then, is to learn from industry sources in networking, franchise documents and published ratios.
Let’s Look Briefly at Free
Be forewarned that “free” activities often have costs. Your time has an “opportunity cost.” That’s what else you could be doing with your time that might be more productive. For example, you may bring in more revenue if you call prospects and close sales than if you write press releases. So you decide to pay someone else to do PR.
Clients often talk about email marketing as free. Who’s writing all those emails to prospects and customers? Who will handle the email database, analyze results, refine the lists, deal with bad emails? This takes time and has costs.
Don’t wave your hands and say free viral marketing or word of mouth. These are not as easy as they sound. Writing articles, creating products to give away, setting up affiliate programs and the like all take someone’s time.
Activities that seem free may cost you or an employee in time.
Bankers, investors, and SCORE counselors — all of us readers of your business plan — don’t expect precision. We know you are a startup. But we want to see your business succeed. And one key to success is cost control. So we want to know that you have thought through potential costs and made reasonable estimates. Use my three methods: competitive quotes, breakdown/rollup, and industry sources to make sure your estimates are solid.
We don’t want to see these quotes and rough calculations in the business plan itself. But we want to know you have them to back up your estimates. Furthermore, after the first year, you can examine how actual costs differed from estimates to understand and improve your profitability going forward.
Industry Ratio Links:
Startup Finance Links:
Estimating Startup Costs for a New Business Startup Nation
Small Business 101: Pay Yourself First Tips from SCORE
Financial Projection Model (SCORE’s Excel sheet. it’s complex, but complete)
Estimating Unknown Expenses by Tim Berry, Bplans.com
Estimating Realistic Startup Costs by Tim Berry, Bplans.com
What problems have you run into in estimating expenses? Please leave me a comment.