There's more than one way to measure your success. Some people may be interested in sales while others might want to see profit margins. But if you're looking at your new company from an investors' point of view, then there's only one thing that matters and that's ROI (return on investment). The question now becomes what is the cost of creating a successful business venture? How can we determine this value?
The traditional approach was to look at financial ratios such as return-on-investment (ROI) and cash flow statements. These were used as indicators of whether the startup had been profitable enough. However today, many entrepreneurs have moved away from these metrics because they don't give them useful information about the true viability of their ideas. They also don't provide helpful insights into areas where startups need improvement. In order to assess the real worth of a business idea, we must take some additional steps. We'll discuss three different approaches below.
Firstly, let's consider the basic concept behind cost analysis which states that all production always comes with associated overhead costs. There are several ways to calculate this figure including:
· Average unit price per product sold multiplied by total number units produced over a period of time. This will include fixed costs such as rent, utilities etc.
· Total revenue divided by the sum of variable costs plus total fixed costs. Variable costs consist mainly of wages, taxes, interest payments, insurance premiums, marketing and advertising. Fixed costs usually comprise salaries, rents/loans, utility bills, legal fees etc.
· Divide overall revenues by gross margin expressed as a percentage. Gross Margin = net sales - direct labor payroll + materials + shipping charges - other indirect operating expenses.
· Add up all of the above and divide by the number of products being considered. For example, if your average selling price is $50,000 and your annual overhead costs add up to $40,000, then your marginal cost equals $10,000. If the market demand for your product increases so too does your overhead costs. Your ability to make money depends upon how quickly you can increase prices without losing customers. When doing a cost analysis, keep in mind that companies should focus on "net" income instead of gross profits when calculating their own overhead costs. Net Income is calculated after deducting tax liabilities and employee benefits.
Costs vary greatly depending on the type of business. A manufacturer or supplier needs to pay for raw material, packaging, transportation, inventory storage, distribution, office space, lighting, heating, electricity, water, building maintenance & repairs, cleaning services, security, accounting & auditing and even entertainment like meals and gifts! All businesses incur costs for things like IT systems, phone lines, furniture, travel, training, postage and stationery. And just think about those consultants who charge hourly rates based on supply contracts. What do they spend each day?
We've already mentioned two key factors required for running a business: 1.) Profit must exceed costs 2.). Demand has got to outweigh Supply. To illustrate this further lets compare a start-up restaurant versus a franchise fast food outlet. Let's say both restaurants sell burgers for $2.00 each and operate under similar circumstances. Both begin operations with a small opening menu consisting of hamburgers, fries and soft drinks. As the owner of the franchise you decide to offer more variety by adding chicken sandwiches, salads and milkshakes. You also open another store closer to the original location. So far so good right? Well here's where the difference lies...
When starting out you'd expect the first year sales to cover initial equipment purchases, lease payment and perhaps some salary costs. At least until you could generate sufficient cash flow to hire employees. With the franchised burger joint however, the owners are guaranteed a certain level of profit every month regardless of what happens to consumer spending habits. Their suppliers guarantee them a predetermined amount of dollars for each item purchased. Also unlike most small businesses, franchises get paid before serving the customer. Franchisees generally receive their monthly checks well ahead of service delivery. Even though the same items are priced higher at the franchise outlets, since their markup covers operating costs, no matter how low consumers choose to shop they won't affect the bottom line.
So why go through all the trouble of setting up a business? Why not work for someone else? One reason is freedom. Having control allows us to run our businesses according to our individual preferences and goals. Another benefit is flexibility. Working for yourself provides greater opportunities to expand your skills and knowledge base. It gives you the chance to set your own hours and schedule. Most importantly, it affords the entrepreneur the opportunity to create something unique and special.
As you can see, it takes time and effort to build a solid, sustainable business. That said, the rewards are rich indeed. Here are five tips for anyone considering launching a new enterprise.
Don't quit your job to pursue your dream. Many ambitious individuals are tempted to leave their current employment to launch a new business. Don't risk everything yet. Take advantage of your employer's resources, contacts and expertise. Use his connections and credibility to help grow your fledgling company. Make sure you understand the terms of your contract and try to negotiate for better compensation packages. Remember that if you fail, he still owes you six months severance!
Do your research. Before jumping headfirst into the entrepreneurial pool ask yourself these questions: Is my idea really feasible? Can I execute it successfully? Am I willing to devote adequate time and energy? Do I know how to reach potential clients? Have I done my homework? Are competitors offering comparable products or services? Who's going to finance my efforts? Will I be able to find qualified staff? Can I afford mistakes along the way?
Be prepared to invest. Starting a business requires capital investments ranging between zero to millions of dollars. Whether it's purchasing land, property, machinery, or developing prototypes, you should plan to put down somewhere between 10% and 100%.
Have realistic expectations. Launching a new business isn't easy and failure is likely. Despite your best intentions, unforeseen obstacles may arise. Be ready to adapt and adjust. Realize that mistakes happen so learn from them and move forward.
Seek professional advice. Hiring experts can save you years of trial and error. Talk to attorneys, accountants, bankers, designers, engineers, marketers, scientists, nutritionists and public relations specialists. Find mentors, coaches and advisors who are familiar with working within specific industries. Ask them to recommend reliable sources for supplies, services and financing options.
Remember that a viable business model must be simple and straightforward. Complexity often leads to confusion and ultimately abandonment. Keep your plans focused on achieving measurable results. Don't try to accomplish too much in a single step.
One final word of wisdom regarding costing your business idea. Cost estimation is critical when deciding whether or not to proceed with your innovative idea. By performing a thorough analysis you can identify possible pitfalls early on preventing you from wasting precious time and money. Three important aspects to consider when estimating your projected costs are:
1. Time frame
You want to ensure that you are capable of producing your product(s) within the allotted timeframe. If you anticipate taking longer than normal due to delays caused by manufacturing defects or quality issues, you will need to factor in extra funds. Otherwise, you may end up having to buy back merchandise and absorb the loss.
2. Quality Control Issues
Your product should meet industry standards and adhere to strict regulations designed to protect consumers. Poorly manufactured goods require added inspection costs. Expensive components that break during assembly may mean increased warranty claims. Determine who is responsible for ensuring compliance and what system exists to resolve problems if needed.
3. Marketing Costs
Marketing is essential for getting your product to prospective buyers. Advertising media like billboards, television ads, radio spots, print advertisements, coupons and online promotions can range anywhere from free to thousands of dollars. Consider using social networking sites like Facebook, Twitter and YouTube to gain exposure. Other promotional strategies include holding contests, giveaways, trade shows and live events.
Once you have determined the estimated cost of a particular project, you can evaluate its profitability. Four common techniques are used to analyze costs.
Fixed Overhead Costs
These are costs that remain constant throughout the life cycle of the project. Examples include rent, salaries, utilities, insurance, telephone usage etc.
Variable Overhead Costs
Overhead costs incurred daily or weekly and fluctuate with changes in volume. Common examples include janitorial, catering, clerical work, housekeeping and laundry duties.
Direct Labor Costs
Employees directly involved in making finished products. Direct labor includes workers hired specifically to produce your product and administrative personnel. Workers are compensated either hourly, piece rate or salaried basis. Administrative personnel support the operational activities of your organization and normally fall outside the scope of wage estimates.
Indirect Labor Costs
When we create businesses, we often need to know if they will be profitable. We also want to know about other factors like the time needed to reach profitability and whether there is any chance that our business could go out of existence after its launch. There is no simple answer because each business has different objectives. However, some general rules can help us make informed decisions.
A good way to think about this question involves looking at several variables in order to determine the overall effects on your company's bottom line. You should consider all possible scenarios such as the following:
- The market potential - What products or services are available in the market?
- Your product portfolio/services offered - How many different types of products or services will you offer? Will you have only one type of product? If so, which ones?
- Financial structure - Can you afford to start up with the capital required? Do you intend to raise money from investors? Are you going to use bank financing or borrow funds through loans?
Once these questions are answered, then we can look into more specific information such as the actual startup costs involved in creating a new business. In addition, every entrepreneur must understand the basic elements of financial management in order to manage their finances effectively during operation. These include accounting principles, tax laws, cash flow statements, budgeting, etc.
As mentioned earlier, not all entrepreneurs set out to run a successful business right away. Some companies may take years before they begin generating positive returns. Therefore, we cannot expect everyone who starts a business to immediately generate profits. As long as the objective is met within reasonable expectations, we can say that the initial investment was worthwhile.
In order to better evaluate the total cost associated with starting a business, let's examine three examples: (1) Sarl (Société Régie Autonome), (2) URL (Unité de Recherche et d'Enseignement), and (3) SA (sans affichage). Each entity represents a unique business model and provides various benefits based on local regulations. But first, let's discuss what constitutes a "cost" factor when deciding how to form a business entity.
Cost analysis helps you decide which legal status would best suit your needs by considering both operational and fixed assets. For example, if you plan to conduct research activities, you might want to choose a particular legal form depending upon where those activities occur. A researcher working in France typically uses a URL while someone located in Canada would most likely select a SA.
The goal of evaluating a proposed activity against existing or past operations is to compare similar situations and identify areas of duplication or difference. It is important to note that a cost comparison requires detailed knowledge of operating procedures. This means that you should spend adequate time studying industry trends, regulatory requirements, contracts, licensing agreements, and intellectual property rights.
You should develop a list of all significant items necessary to operate the proposed enterprise. Based on this list, you can assess the viability of the venture and estimate the amount of resources needed to implement the project successfully. Once you've identified all relevant costs, you can analyze them according to four main categories: direct costs, indirect costs, interest charges, and taxes. By doing this, you'll gain insight into the true cost of producing a certain output.
Direct Costs represent expenditures directly related to production processes. Direct labor includes salaries, wages, overtime pay, and bonuses paid to employees. Other direct costs include utilities, rent, supplies, repairs and maintenance, insurance, depreciation, payroll fees, printing, transportation, advertising, office space, travel, telephone, postage, and mailing. Indirect costs refer to revenues lost due to forgone income resulting from employee turnover, absenteeism, productivity loss, and reduced efficiency. Interest charges consist of all payments made to finance debt incurred to acquire equipment and materials used in production. Taxes reflect revenue losses caused by increased sales volume and higher taxable earnings.
For purposes of simplicity, we're using the terms "startup costs" below to describe the initial investments necessary to get a business started. Of course, every business owner must decide whether he wants to incur additional startup costs in anticipation of future growth opportunities. And keep in mind that the term "cost" is relative to the scope and size of the business. Smaller businesses usually require less funding than larger enterprises even though the latter tend to provide greater return for investors.
Let's now apply cost analysis to three common types of entities. First, let's review the formation of a SARL. A Société Anonyme Reglementée (a.k.a., SARL) is a limited liability corporation organized under French law, whose primary purpose is the development, manufacturing, distribution, sale, and marketing of industrial products and consumer goods. To qualify as a SARL, shareholders must meet strict criteria including having been established legally according to applicable laws and being registered with authorities.
Next, let's talk about URL (Uniteur Rendu Liable): a private foundation created under Belgian legislation. Similar to a nonprofit organization, a URL exists solely to support charitable work. Unlike a charity, however, a URL receives donations without making any profit itself. Like a commercial enterprise, a URL relies heavily on grants, subsidies, donations, membership dues, and fundraising events. Donors contribute toward the URL's mission to promote scientific education, medical care, cultural life, public welfare, environmental protection, social progress, or religious harmony.
Finally, let's move onto SANS (for sociétés anonymes sans parapluie) or SA(N)P(AS): unincorporated associations formed under Swiss municipal statutes. Although a SA is not officially recognized by the government, it still enjoys freedom of action. Because it operates outside of formal structures, members enjoy more flexibility regarding decision-making and ownership issues.
To sum things up, if you plan to incorporate, you must consider several factors, such as the number of owners, the nature of ownership interests, organizational hierarchy, corporate governance guidelines, annual reports, directors' meetings, human resource policies, filing requirements, reporting standards, succession planning, exit strategies, shareholder disputes, risk management, and compliance issues. Depending on your country's regulations, you may find yourself dealing with multiple layers of bureaucracy. So, make sure you thoroughly study your options prior to incorporating. Also, remember to consult a lawyer experienced in drafting documents relating to incorporation.
Now that we've examined the concept of startup costs, let's turn our attention to cost analysis formulas.
Before proceeding further, please bear in mind that cost analysis is highly dependent on the data provided. For instance, if your records contain inaccurate figures, you won't receive accurate results.
Startup costs depend largely on two major factors: the scale of the planned operation and the complexity of the process. Let's assume that you were just licensed to open a restaurant franchise and wanted to purchase 20 tables and 10 chairs. Obviously, you'd be able to buy these items cheaper than if you intended to construct 500 tables. Similarly, hiring a contractor to build a building would probably be more expensive than constructing the same structure yourself.
On the other hand, suppose you own a small factory with five workers and produce 100 units per year. Even though it appears simpler to hire another worker or upgrade outdated machinery, it actually takes longer to complete projects involving fewer people. Since the task at hand is relatively easy, overhead costs should remain low. On the contrary, large organizations usually face high overhead costs since the tasks they perform involve numerous steps.
Another key point to consider relates to the length of the contract. Short-term contracts generally result in lower prices than long-term deals despite the fact that the former don't always guarantee stability. Why? When short-term contracts come to end, service providers are faced with rising inventory levels and obsolete technology. Long-term contracts allow vendors to reduce risks associated with price fluctuations over time.
So, why did we mention above that startup costs vary greatly based on scale and complexity? Simply put, the smaller the scale, the lesser the impact of changes in demand or supply. For example, assuming that you intend to expand your catering business to serve 200 guests instead of 50, the increase in clientele will obviously affect your costs. Conversely, scaling up doesn't necessarily mean increasing prices unless you charge extra for added value. Moreover, complex projects pose serious challenges since they entail lots of steps with interdependent components. Under these circumstances, suppliers may become reluctant to accept bids unless competitive rates are guaranteed.
Given these insights, let's proceed to learn how to derive the cost basis of a given asset.
Here's an example of how to determine the cost basis of a computer system:
Starting your own business requires some investment. Whether you're starting an online store selling handbags and purses on eBay, or setting up a new restaurant in downtown Manhattan, there's going to be initial startup costs that will need to be covered before you can begin operations. However, there are also other factors to consider when analyzing whether a certain business idea should go forward.
The first step towards launching any type of enterprise is determining its total annual budget. This includes all necessary operating expenses such as rent/mortgage payments, utilities, inventory purchases, supplies, advertising expenses (e-mail marketing), salaries, etc., which must exceed revenue earned by at least 10 percent in order to cover these ongoing expenses without turning a profit. In addition, many businesses require additional cash reserves of several hundred thousand dollars to ensure their survival during periods of economic downturns or unforeseen circumstances. These "bailout" funds may only be used if another investor decides not to back them out after they've been established for three years.
Next, we'll take a look at one example scenario where a small retail shop owner was able to establish his or her business with little financial support from outside investors. We will then move onto explaining the different types of financing options available for starting a new business, including loans, credit cards, grants, crowdfunding platforms, and more. Finally, let's explore why so many entrepreneurs choose to bootstrap their way through the process rather than turn to traditional bank funding.
In this case study, we are assuming that our entrepreneur has already decided upon the location he or she wants to set up shop. The next step would involve creating a working space plan and drawing up blueprints for constructing the building. Once construction begins, workers would erect walls, floors and ceilings while installing plumbing fixtures, lighting systems, heating and air conditioning ductwork, electrical wiring, cabinets, shelving, counters and appliances -- basically anything else needed to make sure the finished product looks professional. Any renovations required to bring the interior design into compliance with local codes would fall under separate categories. After everything is completed, the final step would include getting city approvals and permits, hiring staff employees, purchasing equipment, stocking shelves and preparing invoices. All told, a basic retail establishment could run anywhere between $100,000 to $750,000 just to get started! And don't forget about property taxes, insurance, licenses, union fees, licensing, zoning, permitting, inspections, payroll tax, sales tax, utility bills, rent, mortgage interest, maintenance, advertising, security, cleaning services, kitchen upgrades, remodeling, repairs, employee benefits, legal consultation, intellectual property protection, website development, office furniture, computers, software, printing, postage, shipping & receiving, delivery vehicles, vehicle storage and parking facilities, inventories, office supplies, emergency response plans, disaster relief recovery and staffing needs.
But wait, doesn't anyone ever succeed entirely on their own? Yes, there are people who have founded successful companies with very limited capital investments. For instance, a friend of mine named Dan recently opened up a coffeehouse called La Colombe using nothing more than savings from his job at Banknorth as well as loaned money from family members. Another person, Richard Branson, founded Virgin Records in 1966 with £1 million ($2.8 million) raised mostly from friends and associates. But even though those guys were extremely lucky, most budding entrepreneurs never come close to seeing the kind of success they'd like because they simply lack enough resources to keep things afloat until profits kick in.
So now we know that running a business typically involves lots of upfront costs, but do you really need thousands of dollars to launch your dream venture? Absolutely not. If you want to open a sandwich shop in New York City, you certainly won't need hundreds of thousands of dollars worth of real estate, furnishings, machinery, computer hardware and software, inventory, trade show displays, transportation, catering, electricity, phone service, security, health care coverage for yourself and employees, liability insurance, worker's compensation, unemployment insurance, property taxes, license requirements, permit applications, training programs, labor laws, Internet access, janitorial services and food deliveries -- unless you're planning to use a franchise operation for your sandwich shop. It goes on and on. You see, the truth is that almost every aspect of owning a regular brick-and-mortar storefront can be outsourced for far less money than it takes to build a functional web site. On top of that, there are plenty of ways to reduce overhead costs once you become profitable without having to raise large sums of seed capital. So here are some ideas to help you save big bucks:
Sell something locally instead of importing it - Why pay high import tariffs when you can sell products directly to customers within your community?
Use free graphics and photos instead of paying graphic artists - Do you think stock photo sites charge you for images? Of course not. They just put ads against them.
Do away with fancy menus and expensive restaurants - Instead offer simple meals that cater to locals' tastes and preferences. Let the quality speak for itself.
Don't advertise - Advertising is costly and often ineffective. Focus on word of mouth instead.
Offer discounts - People love bargains and freebies. That's why discount stores are always busy even when times are tough. Give discounts and promotions and watch your bottom line grow.
Cut down on waste - Use reusable materials whenever possible. Recycle cardboard boxes, newspapers, old magazines and catalogues, printer paper, scrap metal, plastics, glass bottles and cans, electronic components, fabric scraps, yarn and clothing donations, expired produce, dairy products, dry goods, canned foods, frozen vegetables, herbs and spices, wood chips and sawdust. Donate blood plasma and sperm. Support farmers markets. Buy organic. Try bulk buying. Bulk items usually end up being cheaper anyway.
Crowdfunding is a relatively modern phenomenon whereby a group of individuals pool together their resources to fund projects that wouldn't otherwise receive any government assistance or private sector backing. One popular method of doing so is via websites like Kickstarter, IndieGoGo and RocketHub.com, which allow users to donate money toward specific creative endeavors and receive rewards based on the amount contributed. Since its inception in 2009, Kickstarter alone has helped power over 75,000 campaigns involving everything from movie productions to inventions to music albums. Like giving tips at a restaurant, tipping your crowd helps promote goodwill among peers and makes everyone feel good about donating collectively. More importantly, however, crowdfunding allows for greater transparency, accountability and creativity in terms of project requests. As long as the goal is legitimate -- say, making a short film -- backers tend to trust that the creators will follow through and deliver. Also, since each campaign receives personalized feedback regarding projected revenues and overall performance, it encourages continuous improvement and better outcomes. Plus, the public nature of crowdfunding provides clear visibility to potential investors and lenders, further boosting confidence and efficiency.
As you can see, investing in a business isn't quite as daunting as it might seem at first glance. Even if you decide to hire someone to manage day-to-day affairs for you, chances are you'll still find yourself spending more time thinking creatively about how to maximize productivity and profitability than you would dealing with paperwork. With that said, remember that the main reason entrepreneurs take risks today is because they believe passionately in the vision behind their dreams. While failure can sometimes sting worse than the proverbial knife wound, it can also serve as valuable lessons learned. Nowhere is this truer than for entrepreneurs who refuse to give up despite hardships and obstacles standing in their paths.
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