Are you looking to start a new business? While an exciting endeavor, it can also be an expensive one. You’ll need to register your business (insert card), set up a marketing plan (insert card again), and the list goes on. Most every step is going to come with a cost. However, a well-researched budget will help you avoid unwelcome surprises.
Not sure where to start? Here are the four key steps to creating a budget for your new business. Plus, learn how to fund your startup costs, and get answers to frequently asked questions about startup business budgets!
4 Steps to Creating a Startup Budget
Confused about how to budget for your new small business? Not to worry — below you'll find 4 steps to guide your financial planning.
- Identify Your Cost Types
The first step is identifying the different types of startup costs you'll face. Don't worry about the cost of each expense yet — just focus on the types of expenses you'll incur. To get your wheels turning, here are some of the common costs that most small businesses include in their budgets.
Common business startup costs
While expenses can vary depending on your type of business (online, brick-and-mortar, or service-based), common costs include:
- Advertising and marketing expenses: Building a website, performing market research, establishing a presence on social media, launching online and offline marketing strategies, creating collateral, etc.
- Business establishment: Forming a company, registering it in your state, and getting a business license or permit.
- Equipment and supplies: Buying the equipment and supplies necessary to run the business (e.g. restaurants would need ovens, ranges, food processors, dishes, cutlery, etc.)
- Financial fees: Paying fees to banks and credit card processors for accounts and transactions.
- Insurance: Purchasing business insurance policies such as those for general liability, commercial property, and business income.
- Inventory: Investing in inventory upfront (for product-based companies).
- Labor: Hiring executives, employees, and/or contractors and paying their wages.
- Legal fees: Setting up legal agreements, contracts, and policies.
- Office space: Renting or buying office space for the business.
- Office supplies and furnishings: Buying desks, chairs, couches, tables, paper, pencils, and more for the office.
- Packaging and postage: Packaging and shipping for physical products.
- Technology: Buying accounting software, security tools, cloud services, apps, subscriptions, etc.
- Unexpected costs: Building an emergency fund so you have spending money available for unforeseen costs.
- Utilities: Paying electricity, water, phone, internet, etc.
While these are common costs, you may be wondering how to find the ones specific to your business. To start, take some time to think over what you'll need to conduct business and make a list. Then, make sure you didn't miss anything by asking other business owners with similar business types or researching the expenses for your specific business online.
- Estimate Your Small Business Expenses
Now, with your list of business cost types in hand, it's time to estimate how much each expense is going to cost you. A good place to start is breaking down the costs into two categories — one-time costs and ongoing costs. Then, research each expense type.
For example, if you need office space, you can look up the average rental cost per square foot in your city. In Los Angeles, for example, it sits at $3.31 per square foot (according to Get Digsy). So if you know you need a 1,000-square-foot office space, you could estimate around $3,310 per month ($3.31 per square foot x 1000 square feet). To further vet your estimate, you can shop around and compare it to current rental prices for actual offices in your area.
The bottom line? The research part can take a bit of time but will be worth it. It helps to ensure you have an adequate amount of funds for a successful business launch.
Pro tip: When estimating business costs, err on the side of overestimation. It's better to plan for a higher amount and owe less than to expect a lower amount and be repeatedly blindsided by extra expenses.
- Add Up All of Your Costs
Next, it's time to add everything up to get an understanding of your total costs. Start with the one-time expenses, which should be pretty straightforward (hint: a lot of them are listed up top). Then, move to the monthly, ongoing expenses.
For your ongoing expenses, you'll need to decide how many months you want to include. If you want your budget to show how much your business is going to cost in the first six months, include six months of monthly expenses. However, if you plan to seek startup funding, the U.S. Small Business Administration (SBA) recommends that you include at least one year's worth of monthly expenses.
Further, be sure to consider the difference between fixed and variable costs. Fixed costs are not impacted by volume changes, while variable expenses do change as volume changes. Here are some examples.
Examples of fixed costs:
- Rent payments
- Salaries
- Utilities
- Insurance premiums
Examples of variable costs:
- Packaging supplies
- Raw materials
- Credit card fees
- Bank account fees
When estimating your expenses, take note of the variable costs that will increase as the volume of your services or goods sold increases. For example, you may want to steadily increase your estimated costs for credit card fees to correlate with your expected revenue growth.
- Estimate Your Cash Flow
Now that you have an estimate of how much starting and running a business is going to cost, it's time to make revenue projections. How long is it going to take to start earning revenue, how much can you reasonably predict you'll earn in the coming months, and when will you hit the break-even point? You can make these predictions by researching your market, analyzing the competition, and nailing down your pricing.
Based on your research, estimate how many sales you predict to make in each of the coming months of your budgeting period. Then, multiply the number of sales by the price of your product or service to get a revenue figure. Keep in mind, that once you start earning revenue, it will reduce your out-of-pocket costs.
How Can You Fund Your New Small Business?
Once you have a solid understanding of how much your new small business is going to cost you and when you'll start earning a profit, it's time to figure out how you're going to fund your startup expenses. Here are some popular fundraising approaches.
Tap Into Savings
Have savings in place? Great! However, even if you have the money on hand, you may want to consider your financing options so you don't drain your savings. If you do decide to use your savings, a common financial guideline is to keep an emergency fund that can cover at least six months of your regular living expenses.
You can also treat your business as a “risky” investment as part of your savings portfolio. You could consider redirecting up to 5% of your savings to your business instead of your savings account.
Apply For An SBA Loan
The SBA offers loans for new, for-profit small business owners. The Microloan, in particular, is designed for new businesses and offers qualified borrowers up to $50,000. However, to qualify, you'll often need to meet an intermediary lender's credit requirements, provide some type of collateral, and provide a personal guarantee. The origination process can also take much longer than the quick funding offered by online loan providers.
Use Your Personal Credit
Another option is to leverage your personal credit. Many new business owners resort to personal loans and credit cards because they can't get approved for business loans yet. Traditional and online business lenders typically want to see proof of a reliable business cash flow before you can qualify. While personal loans and credit cards can be helpful, they aren’t ideal as you'll be personally liable for business debts. Further, it will limit the credit you have available for your personal needs (home, cars, etc.).
Using personal credit to get started isn’t a bad thing — just make sure that’s it’s temporary.
Build Business Credit
Last but not least, business loans and credit cards enable you to borrow as a business entity and don't always require a personal guarantee. However, when you don't have any business credit history (as a brand new business owner), you'll have trouble getting approved. That said, you can fast-track the process by getting a secured business card that reports to the main business credit bureaus. You'll need to put a deposit on the card and will receive a spending limit equal to that amount. From there, you can use the card and pay it off each month to quickly establish a positive record on your business credit records. From there, you'll likely have more business credit options available in the near future.
Frequently Asked Questions About Startup Business Budgets
Still have questions? Here's a look at answers to some of the most frequently asked questions about startup business budgets.
How much does it cost to run a business in the first year?
Costs can vary greatly from one business to the next. However, Shopify reports that the average business spends about $40,000 in the first year on expenses.
Can I write off startup expenses?
Startup costs that you incur before the business begins operations are typically considered capital expenditures. They are part of your basis in the business. However, you can deduct up to $5,000 of start-up costs and $5,000 of organizational costs, as per the IRS. For reference, start-up costs include expenses that were paid while researching, creating, or acquiring your business. Organization costs include the costs of creating your partnership or corporation.
What business can you start for $5,000 or less?
There are a variety of businesses that you can start with a very low amount of capital, primarily online service-based businesses. For example, becoming a virtual assistant, transcriptionist, freelance writer, freelance designer, consultant, or coach can all involve very little overhead. Offline service-based businesses such as dog walking, pet sitting, house sitting, and event planning can also be low-cost.
What are business credit scores based on?
Like personal credit scores, business credit scores assess the risk of the report holder. However, instead of an individual, it's a business with an Employer Identification Number (EIN). To assess risk, the business credit bureaus (Equifax, Experian, and Dun & Bradstreet) review your payment history with lenders, suppliers, and vendors. They also consider information such as your time in business, bankruptcy filings, UCC filings, and other liens. After collecting and analyzing the information, they assign businesses a variety of credit scores to asses the risk they present in different areas.
Last Word on Managing Your Small Business Budget
While creating a budget will help you prepare for your first year in business, it's important to keep tabs on it. You'll want to check in on your financial data at the end of every month to compare what you actually spent against what you planned to spend (accounting software can be very helpful here). Then, at the end of the year, perform an in-depth financial analysis. By the start of your second year, you'll be able to improve your budgeting accuracy by referring to real data and trends from your first year.