1-2-3: Small Business Startup
Planning Costs and Expenses
(Date posted: April 2, 2009)

During this step in your small business startup, you plan how to minimize your costs and expenses. This will make your business venture profitable as soon as possible.

Before starting this step, you should have:

• Refined your product's features
• Developed the sales program to solicit customers
• Designed your venture's organization and operations
• Listed the startup requirements for your venture

The previous steps show you how to do this.

The desired result of this step is a list of costs and expenses to use for your initial business operations.

You will use the following topics to complete this step:

Guidelines
Procedures
Example
Go or no-go decision

You will be using this list of costs and expenses in future steps to prepare for the initial business operations.

IMPORTANT

Before using this information to start a business be sure to read the following notice: Disclaimer

Guidelines

These guidelines have the following subtopics:

Examples of various fixed expense levels
Analysis of results for fixed expense levels
Ways to reduce costs and expenses

By spending some time to plan your costs and expenses on paper, you can see your probable results ahead of time.

If these results are favorable, you will have the incentive to continue with your small business startup.

If these results are not favorable, you can either return to a previous step or decide not to try starting your own business. Either way, you will have saved yourself a lot of trouble.

Examples of various fixed expense levels

One of the main causes of business failure is having excessive costs and expenses in relation to the sales volume. To overcome this problem you need to use low costs and expenses when the business first starts.

The lists linked below show the adverse effects of using high fixed expenses when a small business venture first starts out.

As shown by these examples, you are better off with low fixed expenses until sales grow to a high level.

To see these three detailed lists, use the link below.

Lists of various fixed expense levels

Analysis of results for fixed expense levels

Based on the lists linked above, this is how to show a profit at various sales levels.

When you first start a business venture, you probably will have low sales. Your startup costs and fixed expenses need to be very low to show a net profit.

As your sales begin to increase, you are still better off having startup costs and fixed expenses that are very low.

It is only when your sales start reach a high level that you begin to be better off with higher fixed expenses. This is due to the decrease in the percentage rate of variable expenses.

So I always recommend doing whatever it takes to lower the startup costs and fixed expenses for your small business startup.

Ways to reduce startup costs and fixed expenses

Before you start planning your costs and expenses, you can review the following ways to minimize them.

Use bootstrap methods whenever possible -- Visit the Bootstrap Methods page in another section for various ways to reduce expenses.

Eliminate unneeded costs and expenses -- Resist the temptation to splurge on things you don't really need. You normally don't need new furniture for a home office. Buy used furniture, or go without. Be frugal.

Use variable expenses for fixed expenses -- Instead of hiring a sales person at a fixed salary, pay a commission or finder's fee based on a percentage of the sales generated. Besides changing a fixed expense to a variable expense, you also are paying only for actual results.

Procedures

So far, you have seen the adverse results of having high fixed expenses. You also have seen various ways to reduce these fixed expenses. Now you will plan the costs and expenses for your own small business startup.

When an exercise calls for paper and pencil or pen, you may prefer to use a spreadsheet or word processing program instead.

These procedures have the following subtopics:

Example of planned costs and expenses
Calculation of break-even sales level
Results for planned costs and expenses
Prepare your list of costs and expenses
Calculate your break-even sales level

I am using the above links to help you quickly find what you want. This step is rather detailed and complicated because it deals with the essence of what makes your business a success or failure. That essence is the amount of costs and expenses that you allow to happen.

By planning your costs and expenses ahead of time, you can better control these matters.

Example of planned costs and expenses

Now that you have seen how to reduce fixed costs and expenses, it's time to review an example. The list linked below shows the planned costs and expenses for a proposed part-time (weekends) house painting venture.

For this example, it was assumed that the business owner already had a pickup truck and painting equipment. Also it was assumed that the wife of the owner would take care of all the bookkeeping and preparation of tax forms. Thus expenses that otherwise might have been shown were not needed. Fixed expenses are based on 12 months of operation. Startup costs are amounts paid prior to starting business operations.

List of planned costs and expenses

This list is summarized below:

The column marked "First Try" was the business owner's initial attempt at planning his costs and expenses. After showing the list to his wife, they were able to reduce some costs and expenses.

The column marked "Second Try" shows the revised plan for costs and expenses. Note how a few simple changes had a profound effect on the expected operating results.

Calculation of break-even sales level

The following example calculates the break-even point for the proposed house-painting business shown above.

The lower the break-even point, the easier it is for a business to be profitable with low sales volume.

This is a rather complicated calculation. But the results allow you to plan for success in your small business startup.

Break-even calculation:

Factors:

BEP is Break-Even Point (sales amount at zero profit)
TFCE is Total Fixed Costs and Expenses (amount)
TVCE is Total Variable Costs and Expenses (percentage of sales)

Total Fixed Costs and Expenses are the sum of all fixed amounts on your list of costs and expenses.

Total Variable Costs and Expenses are the sum of all percentages on your list of costs and expenses.

You can also use subtotals to calculate these amounts, as shown on the example linked above, but this is not necessary.

Formula:

BEP = TFCE / (1 - TVCE)

Calculation for First Try column:

BEP = TFCE / (1 - TVCE)
BEP = 2,000 / (1 - 0.60)
BEP = 2,000 / 0.40)
BEP = 5,000

Calculation for Second Try column:

BEP = TFCE / (1 - TVCE)
BEP = 750 / (1 - 0.64)
BEP = 750 / 0.36
BEP = 2,083

Results for planned costs and expenses

The above example shows the benefit of keeping fixed costs and expenses as low as possible.

The first try, which resulted in total fixed costs and expenses of $2,000, needed sales of $5,000 to break even. As sales increased above this break-even point, the net profit would be 40% of such additional sales.

The second try, which resulted in total fixed costs and expenses of $750, only needed sales of $2,083 to break even. As sales increased above this break-even point, the net profit would be 36% of such additional sales.

In order to reduce the fixed costs and expenses by $1,250, the owner had to make the following changes:

• Eliminate the $1,000 salesman expense (the owner estimated this would increase variable expense for sales commission by 2% and variable expense for finder's fee by 2%, with no adverse effect on sales)
• Buy used furniture instead of new furniture, saving $200
• Eliminate the $50 storage rental

Were these three changes worth making? I think they were. They decreased the amount of sales needed to break even by almost 60%. That is a lot of time and effort saved.

Prepare your list of costs and expenses

For this plan, only consider your main product and the costs and expenses of operating your business while selling this main product. The items and amounts you will list are only estimates. Let's keep things simple.

During the startup period, your fixed costs are whatever you plan to pay during that period. During the operating period, your fixed costs and expenses are whatever you plan to pay for the first year (twelve months) of operation.

Estimate variable costs and expenses as a certain percentage of the proposed sales price for the main product. Use a percentage symbol when listing these values.

Most cost or expense items will be either fixed or variable. In a few cases, you may have to divide an item into its fixed or variable portions.

This plan will use the same format as the house-painting example above.

Get several sheets of notebook paper and pencil or pen. Head up a sheet of paper as "Planned costs and expenses." Draw a vertical line down the middle of the sheet. Then draw another vertical line to divide the right side of the sheet in half, forming three columns.

Head up the first column "Description." Head up the second column "First Try." Head up the last column "Second Try."

Under the "Description" column write down the first category, "Cost of products sold." Under this category, describe any items that vary with sales volume and are needed to produce and deliver your products. Examples are materials, labor, equipment rental, and shop supplies. Indent these items slightly to the right, as in the example.

Under the "First Try" column, enter the amount for each item as a percentage of the proposed sales price for the main product.

After listing all the items for this category you can think of, skip several lines.

Write down the next category, "Variable sales expense." Then describe any items that vary with sales volume and are needed to help promote and sell the main product. Examples are advertising, commissions, and travel. Under the "First Try" column, enter the amount for each item as a percentage of the sales price.

Continue with the other categories in the same manner.

Write down "Fixed sales expense." Describe any items that are fixed amounts and are needed to help promote and sell the main product. Examples are advertising, commissions, and travel. Enter the fixed amount for each item.

Write down "Variable operating expense." Describe any items that vary with sales volume and are needed to run the administrative and general operations of a business. An example is business tax. Enter the amount for each item as a percentage of the sales price.

Write down "Fixed operating expense." Describe any items that are fixed amounts and are needed to run the administrative and general operations of a business. Examples are home office expense, miscellaneous expense, and office supplies. Enter the fixed amount for each item.

Write down "Startup costs." Describe any items that you plan to pay during the business startup period. Examples are business license, initial office supplies, insurance, and cost of equipment and furniture. Enter the fixed amount for each item.

If you need additional sheets, use the same page heading and repeat the title for the pending category.

Do the best you can on your list, but don't exhaust yourself. You may want to quit when you get tired or have trouble coming up with the names or numbers. You can continue the planning later.

After you have completed the list, go on to the following subtopic.

Calculate your break-even sales level

After planning the costs and expenses for your proposed business venture, you can calculate the break-even point. This is where sales are equal to total costs and expenses, resulting in a zero net profit.

Having a low break-even point allows your business to be profitable even with a low sales volume.

After you have taken your first try at planning your costs and expenses, you can calculate your break-even point.

Calculate the "TFCE" and "TVCE" factors as shown on the example above.

Calculation of your break-even point:

Factors:

BEP is Break-Even Point (sales amount at zero profit)
TFCE is Total Fixed Costs and Expenses (amount)
TVCE is Total Variable Costs and Expenses (percentage of sales)

Formula:

BEP = TFCE / (1 - TVCE)

You can calculate your break-even point by putting the above formula into a computer spreadsheet. Or you can calculate your break-even point the long way as shown in the example above.

If you are satisfied with the resulting break-even sales level, you are done with the procedures topic.

If you are not satisfied with the resulting break-even sales level, then go back and try to reduce your planned costs and expenses as in the example above.

Example

This example uses my proposed information publication business.

My planned costs and expenses

Use the following link to see the list of costs and expenses for my small business startup.

List of example costs and expenses

This list is summarized below:

I didn't have many fixed costs and expense, so on my second try I also eliminated a variable expense that I didn't need.

Calculation of my break-even sales level

Now for the decisive moment. What will it take for my proposed small business startup to break even? Here we go.

Calculation of my break-even point:

Factors:

BEP is Break-Even Point (sales amount at zero profit)
TFCE is Total Fixed Costs and Expenses (amount)
TVCE is Total Variable Costs and Expenses (percentage of sales)

Formula:

BEP = TFCE / (1 - TVCE)

Calculation for First Try column:

BEP = TFCE / (1 - TVCE)
BEP = 800 / (1 - 0.40)
BEP = 800 / 0.60)
BEP = 1,333

Calculation for Second Try column:

BEP = TFCE / (1 - TVCE)
BEP = 550 / (1 - 0.25)
BEP = 550 / 0.75
BEP = 733

I wasn't able to reduce the costs and expenses that much on the second try. Nevertheless, I am satisfied with the results.

Go or no-go decision

Go on to the Being Able to Produce the Product step in your small business startup if you can answer "yes" to the following questions:

• Have you lowered the proposed costs and expenses for your small business startup as much as possible?
• Are you satisfied with the sales volume needed to reach your break-even point?

If you have answered "no" to any of the above questions, go to this topic on another page to see what to do next.

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