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Production Plan in Business Plan: A Comprehensive Guide to Success

Last Updated:  

August 22, 2024

In any business venture, a solid production plan is crucial for success. A production plan serves as a roadmap that outlines the steps, resources, and strategies required to manufacture products or deliver services efficiently. By carefully crafting a production plan within a business plan, entrepreneurs can ensure optimal utilisation of resources, timely delivery, cost efficiency, and customer satisfaction. In this article, we will delve into the intricacies of creating an effective production plan in a business plan , exploring its key components, strategies, and the importance of aligning it with overall business objectives .

Key Takeaways on Production Plans in Business Planning

• A production plan : a detailed outline that guides efficient product manufacturing or service delivery.
• Importance of a production plan : provides a roadmap for operations, optimises resource utilisation, and aligns with customer demand.
• Key components : demand forecasting, capacity planning, inventory management, resource allocation, and quality assurance.
• Strategies : lean manufacturing, JIT inventory, automation and technology integration, supplier relationship management, and continuous improvement.
• Benefits of a well-executed production plan : improved efficiency, reduced costs, enhanced product quality, and increased profitability.

What is a Production Plan?

A production Seamless Searches plan is a detailed outline that specifies the processes, resources, timelines, and strategies required to convert raw materials into finished goods or deliver services. It serves as a blueprint for the entire production cycle, guiding decision-making and resource allocation. The production plan considers factors such as demand forecasting, capacity planning, inventory management, and quality assurance to ensure efficient operations and optimal customer satisfaction.

Why is a Production Plan Important in a Business Plan?

The inclusion of a production plan in a business plan is vital for several reasons. First and foremost, it provides a clear roadmap for business operations, helping entrepreneurs and managers make informed decisions related to production processes. A well-developed production plan ensures that resources are utilised efficiently, minimising wastage and optimising productivity. This is particularly important for any startup platform aiming to streamline its production processes and achieve sustainable growth.

Additionally, a production plan allows businesses to align their production capabilities with customer demand. By forecasting market trends and analysing customer needs, businesses can develop a production plan that caters to current and future demands, thus avoiding overstocking or understocking situations. For those interested in property development, understanding the dynamics of the real estate market can provide valuable insights into aligning production capabilities with demand, ensuring successful projects and investments.

Furthermore, a production plan helps businesses enhance their competitive advantage. By implementing strategies such as lean manufacturing and invoice automation , companies can streamline their production processes, reduce costs, improve product quality, and ultimately outperform competitors.

Key Components of a Production Plan

To create an effective production plan, it is crucial to consider several key components. These components work together to ensure efficient operations and successful fulfilment of customer demands. Let's explore each component in detail.

Demand Forecasting

Demand forecasting is a critical aspect of production planning. By analysing historical data, market trends, and customer behaviour, businesses can predict future demand for their products or services. Accurate demand forecasting allows companies to optimise inventory levels, plan production capacity, and ensure timely delivery to customers.

One approach to demand forecasting is quantitative analysis, which involves analysing historical sales data to identify patterns and make predictions. Another approach is qualitative analysis, which incorporates market research, customer surveys, and expert opinions to gauge demand fluctuations. By combining both methods, businesses can develop a robust demand forecast, minimising the risk of underproduction or overproduction. Utilising a free notion template for demand forecasting can further streamline this process, allowing businesses to organise and analyse both quantitative and qualitative data efficiently in one centralised location.

Capacity Planning

Capacity planning involves determining the optimal production capacity required to meet projected demand. This includes assessing the production capabilities of existing resources, such as machinery, equipment, and labour, and identifying any gaps that need to be addressed. By conducting a thorough capacity analysis, businesses can ensure that their production capacity aligns with customer demand, avoiding bottlenecks or excess capacity.

An effective capacity plan takes into account factors such as production cycle times, labour availability, equipment maintenance, and production lead times. It helps businesses allocate resources efficiently, minimise production delays, and maintain a consistent level of output to meet customer expectations.

Inventory Management

Efficient inventory management is crucial for a successful production plan. It involves balancing the cost of holding inventory with the risk of stockouts. By maintaining optimal inventory levels, businesses can reduce carrying costs while ensuring that sufficient stock is available to fulfil customer orders.

Inventory management techniques, such as the Economic Order Quantity (EOQ) model and Just-in-Time (JIT) inventory system, help businesses strike the right balance between inventory investment and customer demand. These methods consider factors such as order frequency, lead time, and carrying costs to optimise inventory levels and minimise the risk of excess or insufficient stock.

Resource Allocation

Resource allocation plays a pivotal role in a production plan. It involves assigning available resources, such as labour, materials, and equipment, to specific production tasks or projects. Effective resource allocation ensures that resources are utilised optimally, avoiding underutilisation or over-utilisation.

To allocate resources efficiently, businesses must consider factors such as skill requirements, resource availability, project timelines, and cost constraints. By conducting a thorough resource analysis and implementing resource allocation strategies, businesses can streamline production processes, minimise bottlenecks, and maximise productivity .

Quality Assurance

Maintaining high-quality standards is essential for any production plan. Quality assurance involves implementing measures to monitor and control the quality of products or services throughout the production process. By adhering to quality standards and conducting regular inspections, businesses can minimise defects, ensure customer satisfaction, and build a positive brand reputation.

Quality assurance techniques, such as Total Quality Management (TQM) and Six Sigma , help businesses identify and rectify any quality-related issues. These methodologies involve continuous monitoring, process improvement, and employee training to enhance product quality and overall operational efficiency.

In addition to the core components of a production plan, it's also important for businesses to consider the broader aspects of their business strategy, including marketing and advertising. Understanding the costs and returns of different marketing approaches is crucial for comprehensive business planning . For instance, direct response advertising costs can vary significantly, but they offer the advantage of measurable responses from potential customers. This type of advertising can be a valuable strategy for businesses looking to directly engage with their target audience and track the effectiveness of their marketing efforts.

Strategies for Developing an Effective Production Plan

Developing an effective production plan requires implementing various strategies and best practices. By incorporating these strategies into the production planning process, businesses can optimise operations and drive success. Let's explore some key strategies in detail.

Lean Manufacturing

Lean manufacturing is a systematic Seamless Searches approach aimed at eliminating waste and improving efficiency in production processes. It emphasises the concept of continuous improvement and focuses on creating value for the customer while minimising non-value-added activities.

By adopting lean manufacturing principles, such as just-in-time production, standardised work processes, and visual management, businesses can streamline operations, reduce lead times, and eliminate unnecessary costs. Lean manufacturing not only improves productivity but also enhances product quality and customer satisfaction.

Just-in-Time (JIT) Inventory

Just-in-Time (JIT) inventory is a strategy that aims to minimise inventory levels by receiving goods or materials just when they are needed for production. This strategy eliminates the need for excess inventory storage, reducing carrying costs and the risk of obsolete inventory.

By implementing a JIT inventory system, businesses can optimise cash flow, reduce storage space requirements, and improve overall supply chain efficiency. However, it requires robust coordination with suppliers, accurate demand forecasting, and efficient logistics management to ensure timely delivery of materials.

Automation and Technology Integration

Automation and technology integration play a crucial role in modern production planning, as well as mobile app development . By leveraging technology, businesses can streamline processes, enhance productivity, and reduce human error. Automation can be implemented in various aspects of production, including material handling, assembly, testing, and quality control.

Continuous Improvement

Continuous improvement is a fundamental principle of effective production planning. It involves regularly evaluating production processes, identifying areas for improvement, and implementing changes to enhance efficiency and quality.

By fostering a culture of continuous improvement, businesses can drive innovation, optimise resource utilisation, and stay ahead of competitors. Techniques such as Kaizen, Six Sigma, and value stream mapping can help businesses identify inefficiencies, eliminate waste, and streamline production workflows.

Frequently Asked Questions (FAQs)

What is the role of a production plan in business planning.

A1: A production plan plays a crucial role in business planning by providing a roadmap for efficient production processes. It helps align production capabilities with customer demand, optimise resource utilisation, and ensure timely delivery of products or services.

How does a production plan affect overall business profitability?

A2: A well-developed production plan can significantly impact business profitability. By optimising production processes, reducing costs, and enhancing product quality, businesses can improve their profit margins and gain a competitive edge in the market.

What are the common challenges faced in production planning?

A3: Production planning can present various challenges, such as inaccurate demand forecasting, capacity constraints, supply chain disruptions, and quality control issues. Overcoming these challenges requires robust planning, effective communication, and the implementation of appropriate strategies and technologies.

What is the difference between short-term and long-term production planning?

A4: Short-term production planning focuses on immediate production requirements, such as daily or weekly schedules. Long-term production planning, on the other hand, involves strategic decisions related to capacity expansion, technology investments, and market expansion, spanning months or even years.

How can a production plan be adjusted to accommodate changes in demand?

A5: To accommodate changes in demand, businesses can adopt flexible production strategies such as agile manufacturing or dynamic scheduling. These approaches allow for quick adjustments to production levels, resource allocation, and inventory management based on fluctuating customer demand.

In conclusion, a well-crafted production plan is essential for business success. By incorporating a production plan into a comprehensive business plan, entrepreneurs can optimise resource utilisation, meet customer demands, enhance product quality, and drive profitability. Through effective demand forecasting, capacity planning, inventory management, resource allocation, and quality assurance, businesses can streamline production processes and gain a competitive edge in the market.

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How to Calculate Business Startup Costs

Starting a business from scratch takes a lot out of you, even before you begin operating—whether it’s about selecting a revenue model, securing startup funding, or estimating startup costs.

I already knew it was challenging for entrepreneurs to calculate the startup costs accurately.

However, when I turned up to my computer, researching this article, I discovered so many challenges new business owners face while estimating startup costs that I had overlooked or didn’t pay much attention to earlier.

Thousands of startups close down every single year. 38% of them fail solely because they underestimated their startup costs and ran out of cash. You can’t ignore something like that, can you?

That said, I’m ready to pour my research into the article to help you calculate your business startup costs .

So, you’re ready to begin? Let’s dive right in.

Key Takeaways

• Startup costs are the expenses a startup must bear in the process of starting a new business, while operational costs are the expenses that are incurred during daily operations.
• Different types of business structures, such as sole proprietorships, partnerships, and corporations, have different costs.
• Business insurance, formation fees, licensing and permits, and marketing are some of the most common business startup costs.
• A modern financial forecasting tool is the most efficient method for calculating startup costs.

How much does it cost to start a business?

Startup costs for a small business depend on various factors like business model, location, industry, and scale of operations. Although it’s tough to estimate precisely, Guidant Financial’s 2023 survey reported that the average cost of starting a small business falls between $50K and $1 million .

You must consider the industry, business category, working capital requirements, and other common expenses associated with the business for the accurate estimation of startup costs.

Let’s kickstart this guide by discussing the common startup expenses to consider while starting a new venture.

Common Business Startup Costs to Consider

It is a typical list of expected business startup costs with rough cost estimates you must plan for while starting a new business. Your actual startup costs will entirely depend on your business category and the industry you serve.

Following are some of the most common startup costs to consider:

1. Equipment and tools

It’s no surprise we’re starting the list with equipment and tools. There’s no way a business can operate without the necessary equipment. The equipment costs may range from $10,000 to $120,000 . However, these costs will entirely depend on the business type and equipment requirements.

For instance, starting a food truck would require financing a food truck and expensive kitchen equipment, while starting a small daycare would only require purchasing a few play area equipment.

Here are the average equipment costs for some of the popular business types:

• Restaurant and food trucks: $24,000 to $120,000+
• Small Bakery: $6,000 to $8,000
• Clothing line: $2,000 to $15,000+
• Construction: $10,000 to $50,000
• Law firm: $5,000 to $25,000+
• Barbershop: $1,000 to $2,000

2. Incorporation fees

The first thing you should do is choose a business entity when you plan to form a new business. The most common and preferred business structure types include sole proprietorship, partnership, corporation, and LLC.

The business incorporation or filing fees can range from $50 to $725 in the United States depending on your industry, the state you operate in, and the business structure you choose.

However, the average incorporation fee is $300 in the majority of the states in the US. You may contact your secretary of state’s website to learn more about the filing fees or process for the articles of incorporation or articles of organization.

3. Business licensing and permits

Operating any small business requires specific licenses and permits depending on the industry compliance and regulations. For instance, a trucking company requires a USDOT number, heavy vehicle use tax, and others, while a restaurant may need licenses like food safety and liquor licenses to operate.

Similar to different filing fees for other business structures, the business licensing and permit fees vary depending on the business industry and regulatory compliance. You can expect to spend between $1,000 to $5,000 for your licensing and permitting requirements.

4. Office or retail space

If you’re starting a small business that can be operated from home like a home bakery or an online clothing store, you may not have to worry about office space costs.

But if it’s not the case, paying for an office or a retail space would make up a sizable portion of your fixed expenses, no matter whether you rent or buy the place.

Based on our research, you should spend around $100 to $1200 per employee monthly on your workspace.

However, the actual office space expense will entirely depend on your location and the type of space you’re using.

5. Legal and professional fees

Professional and legal fees may sound like an additional expense while starting up with limited resources, but it’s essential to ensure compliance with regulations and maintain accurate financial records.

You may choose legal assistance for business licensing, EIN registration, and legal paperwork, a business consultant for market research and strategic planning, and an accountant for bookkeeping and tax planning.

You can hire these professional consultants on an hourly basis; their services typically cost around $40 to $150 per hour.  You should spend around $2,000 to $10,000 per year on professional and legal fees.

6. Inventory

Retail, wholesale, distribution, and manufacturing—if your small business falls under any of the mentioned categories, you need an inventory to operate your business. Finding the ideal inventory size to carry can be challenging when entering a new marketplace.

You want to attract more and more customers and make sales in your early days. However, you can’t also risk having too much inventory since it can increase spoilage.

Consider allocating 15% to 25% of your budget to inventory, depending on your industry. You will eventually learn more about inventory management once your business starts operating and making sales.

7. Marketing and advertising

Although it’s an optional expense, marketing is something worth investing in. Your marketing expenses may include physical materials like sign boards, banners, hoarding, paid social media advertising and search ads, or money paid to marketing agencies or consultants.

It is suggested to keep your advertising and promotion costs under 10% of your budget. If you’re working on a really tight budget, there’s no need to spend big bucks on marketing or hire fancy consultants or agencies.

With social media being a free marketing platform, over 47% of small business owners run their marketing efforts themselves, and you can do it, too.

8. Website development

A business website is like an online office where customers can contact you, learn more about your offerings, and seek assistance.

When building a website, make sure it looks professional, is easy to navigate, and displays the relevant information about your product and service offerings, as well as the contact information.

You can either develop a business website using website builders like Wix and Squarespace or hire a developer to do it for you.

Creating a website can range between $1,000 to $10,000 when you hire a developer, whereas you can do it on your own with website builders by spending around 40 dollars a month.

9. Business Insurance

Like you have a house, car, and health insurance, you need business insurance to ensure your business remains intact in troublesome and inevitable times, be it a natural disaster or a customer filing a lawsuit against your business.

The level of security and type of business insurance your business will require depends entirely on your business, industry, and the number of employees you have. For instance, a big-scale manufacturing company with over a thousand employees would require much stronger insurance compared to a home bakery.

Some of the must-have business insurance types include:

• General liability insurance—for all online, offline, and home-based businesses.
• Worker’s compensation insurance—for businesses with 1 or more employees.
• Professional liability insurance—for businesses offering consulting services.

You must expect to spend approximately $500 to $1500 annually on business insurance.

10. Payroll

Payroll is undoubtedly one of the major business expenses most businesses incur. However, there’s no denying how crucial it is to hire quality employees to make your business thrive.

Of course, payroll expenses are employee salaries, but there’s more to it. Your payroll expenses may also include:

• Incentive or bonus
• Commissions
• Paid time off
• Overtime pay
• Travel allowance
• Other benefits

Most businesses spend around 20% to 50% of their monthly budget on payroll. It can be more or less for your business depending on your business and the number of employees you have.

11. Office furniture and supplies

Those planning to have a traditional nine-to-five corporate workplace, be ready to spend some severe bucks on office furniture and office supplies.

When you operate from a corporate workspace, you need a desk, chair, telephone extension, computer, computer programs like accounting software, and, of course, a coffee machine or two.

The cost of furniture and supplies depends solely on your employee strength and the size of the office. However, it’s recommended to keep your furniture and supply costs to 10% of your total startup costs.

12. Utilities

No matter whether you plan to rent or purchase a workspace, you are bound to pay utility bills that include electricity, gas, water, internet, and phone bills for your office.

Unlike other fixed costs, it’s hard to estimate utility expenses, but the average cost of utilities for commercial buildings is $2.10 per square foot , according to a report by Iota Communications .

Besides the electricity, internet, and phone bills, the utility expenses may also incur the HVAC unit installation costs. This heating and cooling system will add a few additional thousand dollars to your startup expenses.

13. Business taxes

How much you’d spend on business taxes will depend on your business entity, tax-deductible expenses, and revenue. Since it’s hard to predict your revenue, estimating the exact amount to allocate for tax preparation may feel a bit challenging.

Under US federal law, corporations pay a flat 21% corporate income tax . If you’re a pass-through entity(a legal entity that passes all its income on to the owners), the business income or losses will pass through to your personal taxes.

However, you, as a pass-through entity, can claim a 20% deduction on income before paying taxes.

 14. Other expenses

Since you’ve reached this section, you must already have a clear understanding of all the expected startup costs, whether they are one-time or recurring expenses.

Here, we will discuss the other costs most small business owners tend to miss or overlook while estimating the startup costs— research expenses and borrowing costs .

Capital is required for starting a business, and equity financing and debt financing are considered to be the most preferred ways to acquire the initial working capital.

Equity financing, however, does not apply to most small businesses since it requires stock issuance. So, securing a small business loan seems to be the most likely source of debt financing for small business owners.

Research expenses, on the other hand, are the expenses incurred even before you started operating, spent on conducting a careful industry analysis and market research.

When calculating your startup costs, make sure to include these two as well.

Since we have already discussed common business expenses, let’s move on discussing calculating the startup costs.

How to Calculate the Costs of Starting a Business

There are various ways to calculate the cost of starting a business. Still, drafting a business plan remains the best way to estimate startup costs.

The financial forecasting section of your plan provides three to five-year projections of revenue, profit, and expense.

The other resources for estimating startup costs include using Upmetrics’ startup costs worksheet or calculator . These resources will help you estimate the initial investment required and determine how much capital or financing you’ll need.

Know that many of the common business expenses we discussed earlier are recurring, with some of them being one-time expenses.

Be sure to categorize them and calculate the recurring expenses on a monthly, quarterly, and annual basis. In contrast, consider expenses like incorporation fees and equipment financing one-time costs.

Sounds like a lot to digest? Get a business planning software like Upmetrics and calculate startup costs in minutes with AI-powered financial forecasting .

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Calculating Startup Costs for Your Small Business

Does your business fall under one of these categories? Excellent. We have startup cost guides for all the business categories listed below. Get a cost estimate for starting the business you plan to launch.

How to Reduce Your Business Startup Costs

Starting a business means being prepared to bear some non-negotiable expenses; there’s no other way around. However, sound research and thoughtful planning can help you save on high-ticket purchases—ultimately reducing your startup costs.

For instance, hiring professional business plan writers can be expensive for a business owner on a tight budget to create a business plan, so they can opt for a business planning software like Upmetrics to draft a business plan at a much lesser cost.

It was just an example, here are a few tips to help you reduce your business startup costs.

1. Create a business plan

It doesn’t make sense. Isn’t it another business expense? How will it reduce costs? Some of you must be having this line of questioning in your mind, but let us clear it up for you.

Brainstorming and listing all the important business costs, and estimating your total startup costs is challenging. Missing out on some critical expenses tends to happen. However, creating a comprehensive business plan makes things easier.

An AI-powered tool like Upmetrics makes sure you don’t miss out on any critical information and helps you properly estimate your startup costs.

Remember, accurate estimation of startup costs is your first step to reducing them.

2. Start small

You don’t need everything or a perfect business setup when you are not making any sales, forget about the business profits. Start small with limited resources and grow your business as it grows financially.

For instance, instead of having a big fancy office for your startup, start with a remote team or a co-working space until you raise capital or gather the necessary resources.

One way of doing that would be listing all the major high-ticket expenses and researching competitive alternatives for them.

3. Lease instead of purchasing

Of course, having your own office or a retail space feels good, but not at the cost of more than 70% of your budget for starting a business. Prefer leasing the place instead of purchasing.

It will leave you with enough working capital or cash to efficiently manage your business operations and handle the other non-negotiable costs.

Furthermore, there’s no guarantee your storefront will find success at the very first location; you may have to relocate if things don’t work out. The further process will be more straightforward with leasing, whereas the same won’t be the case when you own the place.

4. Buy used equipment, tools, or furniture

Since you’re looking for ways to reduce costs and save money, there’s no way for you to have brand-new business equipment, tools, and furniture. You can look for used equipment, tools, and furniture on online selling sites like eBay and Etsy.

Be sure to thoroughly check the equipment before purchasing to avoid any future restoration or repair costs.

5. Funding and business credit card

Now that you have a long list of capital expenditures, you will need financing or funding to manage all these costs. You can’t simply do it all on your own, can you?

It won’t reduce the startup costs but will help you get resources to manage them. Your funding options include debt and equity financing. You may apply for a business loan, reach out to angel investors, or apply for business grants to secure the initial investment for your business.

With limited debt financing options, it could be tough to get through. Applying for a business credit card can be a more accessible alternative to a business loan. You can easily qualify for it while also gaining a higher credit limit than your personal credit card.

Make sure you’re not totally relying on it or taking out more than you can repay. This can negatively impact your credit score, making it harder for you to secure business loans in the future.

And, the final section leads us to our conclusion!

And there you have it. We hope now you have a better understanding of startup cost calculation. What’s next? It’s time to estimate the actual costs of starting a business, be it a bakery, restaurant, or hot shot trucking, and start budgeting.

Get your hands on the modern and AI-powered business planning solution, Upmetrics—and create precise startup cost projections in minutes, just like that.

Frequently Asked Questions

What is the average cost to start a small business.

It is a question with a broad scope for the answer since you can start a business with an initial investment of $100, $1,000, and up to a million dollars or even more. However, the startup and first-year operational expenses fall somewhere between $30,000 to $40,000.

How do you calculate startup costs?

The most easy-to-use method to calculate startup costs is to create a business plan. It’s easier than ever to calculate your startup costs using a tool like Upmetrics. 

Simply head to the financial forecasting feature, get AI suggestions to list your startup and organizational costs, add remaining costs, and let it make the automated calculations for you.

What are business startup costs?

Business startup costs are expenses incurred when starting a new business. These can be your marketing costs, payroll expenses, or any other costs involved. These can either be recurring or one-time costs. 

For instance, your advertising costs are recurring, whereas incorporation fees are a one-time expense. Although there can be some common startup expenses, the value or costs for them may not be the same for two different businesses.

What is the difference between startup costs and operational expenses?

Startup costs are the expenses small businesses incur when starting a new business, whereas operational expenses are those incurred during normal day-to-day business operations. 

For instance, equipment financing can be considered a startup cost, whereas inventory or marketing costs can be your operational expenses.

What are the examples of start-up costs?

The following can be considered as a few examples of startup costs:

• Equipment costs
• Inventory expenses
• Business licenses and permits
• Marketing and advertising expenses
• Payroll expenses
• And others.

About the Author

Vinay Kevadiya

Vinay Kevadiya is the founder and CEO of Upmetrics, the #1 business planning software. His ultimate goal with Upmetrics is to revolutionize how entrepreneurs create, manage, and execute their business plans. He enjoys sharing his insights on business planning and other relevant topics through his articles and blog posts. Read more

How Much Does it Cost to Start a Business?

8 min. read

Updated April 25, 2024

What will it cost to start your business? This is a key question for anyone thinking about starting out on their own. You’ll want to spend some time figuring this out so you know how much money you need to raise and whether you can afford to get your business off the ground.

Most importantly, you’ll want to figure out how much cash you’re going to need in the bank to keep your business afloat as you grow your sales during the early days of your business. 

Typical startup costs can vary depending on whether you’re operating a  brick-and-mortar store, online store, or service operation . However, a common theme is that launching a successful business requires preparation.

And while you may not know exactly what those expenses will be, you can and should begin researching and estimating what it will cost to start your business.

• How to determine your startup costs

Like when developing your  business plan , or  forecasting  your initial sales, it’s a mixture of  market research ,  testing , and informed guessing. Looking at your competitors is a good starting point. Once you feel your initial estimates are in the ballpark, you can start to get more specific by making these three simple lists.

1. Startup expenses

These are expenses that happen before you launch and start bringing in any revenue. Here are some examples:

• Permits and Licenses: Every business needs a license to operate, just like a driver needs one to drive. Costs vary depending on industry and location.
• Legal Fees: Getting your business structure set up (sole proprietorship, LLC, etc.) might involve consulting a lawyer and at least will involve the basic business formation fees.
• Insurance: Accidents happen, and insurance protects your business from unforeseen bumps.
• Marketing and Branding: The ways to spread the word about your product or service. They could involve creating a website, creating business cards, or promoting social media.
• Office Supplies : Pens, paperclips, that all-important stapler – the essentials to keep your business humming.
• Rent/Lease: If you need to rent space for your business before you start selling, include those expenses in your list as well.

2. Startup assets

Next, calculate the total you need to spend on assets to get your business off the ground. Assets are larger purchases that have long-term value. They’re typically significant items that you could resell later if you needed or wanted to.

Here are a few examples:

• Equipment:  Think ovens for a bakery, cameras for a photography business, or computers for a tech startup.
• Inventory:  If you’re selling products, you’ll need to stock up before opening your doors (or your online store).
• Furniture and Decorations:  Desks, chairs, that comfy couch in the waiting room – creating a functional and inviting workspace might involve some upfront investment.
• Vehicles: If your business requires a vehicle to deliver your product or service, be sure to account for that purchase here.

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Why separate assets and expenses?

There’s a reason that you should separate costs into assets and expenses. Expenses are deductible against income, so they reduce taxable income. Assets, on the other hand, are not deductible against income.

By initially separating the two, you potentially save yourself money on taxes. Additionally, by accurately accounting for expenses, you can avoid overstating your assets on the balance sheet. While typically having more assets is a better look, having assets that are useless or unfounded only bloats your books and potentially makes them inaccurate. 

Listing these out separately is good practice when  starting a business  and leads into the final piece to consider when determining startup costs. 

3. Operating Expenses

Finally, figure out what it’s going to cost to keep your doors open until sales can cover expenses. Create a list that estimates monthly expenses, such as:

• Payroll (including your own salary)
• Marketing and advertising
• Loan payments
• Insurance premiums
• Office supplies
• Professional services
• Travel costs
• Shipping and distribution

Then, based on your revenue forecasts , calculate how many months it will take before your sales can cover all those monthly expenses. Multiply that number of months by your monthly operating expenses to determine how much you’re going to need to cover operating expenses as your business starts.

This number is often called “ cash runway ” and is a critical number – you need enough cash to fund those early red ink months. This number is how much cash you need to have in your checking account when you open your doors for business.

Calculating how much startup cash you need

To figure out how much money you need to start your business, add the asset purchases, startup expenses, and operating expenses over your cash runway period. This is your total startup costs, and it’s better to overestimate than underestimate these costs.

It often makes sense to invest the time to build a slightly more detailed starting costs calculation. Assuming you start making some sales and those sales grow over time, your revenue will be able to help pay for some of your operating expenses. Ideally, your sales contribute more and more over time until you become profitable.

To do a more detailed calculation, you’ll want to invest the time in a detailed financial forecast where you can experiment with different scenarios. If you do this, you’ll be able to see how much it will cost to start your business with different revenue growth rates. You’ll also be able to experiment with different funding scenarios and what your business would look like with different types of loans.

• Funding Starting Costs

You can cover starting costs on your own, or through a combination of loans and investments.

Many entrepreneurs decide they want to raise more cash than they need so they’ll have money left over for contingencies. While that makes good sense when you can do it, it is difficult to explain that to investors. Outside investors don’t want to give you more money than you need, because it’s their money.

You may see experts who recommend having anywhere from six months to a year’s worth of expenses covered, with your starting cash. That’s nice in concept and would be great for peace of mind, but it’s rarely practical. And it interferes with your estimates and dilutes their value.

Of course, startup financing isn’t technically part of the starting costs estimate. But in the real world, to get started, you need to estimate the starting costs and determine what startup financing will be necessary to cover them. The type of financing you pursue may alter your startup or ongoing costs in a given period, so it’s important to consider this upfront.

Here are common financing options to consider:

• Investment : What you or someone else puts into the company. It ends up as paid-in capital in the  balance sheet . This is the classic concept of business investment, taking ownership in a company, risking money in the hope of gaining money later.
• Accounts payable : Debts that are outstanding or need to be paid after a certain time according to your balance sheet. Generally, this means credit-card debt. This number becomes the starting balance of your balance sheet.
• Current borrowing : Standard debt, borrowing from banks,  Small Business Administration , or other current borrowing.
• Other current liabilities : Additional liabilities that don’t have interest charges. This is where you put loans from founders, family members, or friends. We aren’t recommending interest-free loans for financing, by the way, but when they happen, this is where they go.
• Long-term liabilities : Long-term debt or long-term loans.
• Other considerations for estimating startup costs

Pre-launch versus normal operations

With our definition of starting costs, the launch date is the defining point. Rent and payroll expenses before launch are considered startup expenses. The same expenses after launch are considered operating or ongoing expenses.

Many companies also incur some payroll expenses before launch because they need to hire people to train before launch, develop their website, stock shelves, and so forth.

Further Reading: How to calculate the hourly cost of an employee

The same defining point affects assets as well. For example, amounts in inventory purchased before launch and available at launch are included in starting assets. Inventory purchased after launch will affect  cash flow , and the balance sheet; but isn’t considered part of the starting costs.

So, be sure to accurately define the cutoff for startup costs and operating expenses. Again, by outlining everything within specific categories, this transition should be simple and easy to keep track of.

Your launch month will likely be the start of your business’s fiscal year

The establishment of a standard fiscal year plays a role in your analysis. U.S. tax code allows most businesses to manage taxes based on a fiscal year, which can be any series of 12 months, not necessarily January through December.

It can be convenient to establish the fiscal year as starting the same month that the business launches. In this case, the startup costs and startup funding match the fiscal year—and they happen in the time before the launch and beginning of the first operational fiscal year. The pre-launch transactions are reported as a separate tax year, even if they occur in just a few months, or even one month. So the last month of the pre-launch period is also the last month of the fiscal year.

• Aim for long-term success by estimating startup costs

Make sure you’ve considered every aspect of your business and included related costs. You’ll have a better chance at securing loans, attracting investors, estimating profits, and understanding the cash runway of your business.

The more accurately you layout startup costs and make adjustments as you incur them, the more accurate vision you’ll have for the immediate future of your business. 

Tim Berry is the founder and chairman of Palo Alto Software , a co-founder of Borland International, and a recognized expert in business planning. He has an MBA from Stanford and degrees with honors from the University of Oregon and the University of Notre Dame. Today, Tim dedicates most of his time to blogging, teaching and evangelizing for business planning.

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Deciding to start a business is exciting, but can also be daunting if you're a new entrepreneur. Calculating business startup costs, worrying about long-term profitability, securing startup funding — it can all be pretty stressful.

The question of costs is critical because the initial investment can be significant. A Kauffman Foundations study shows the average cost to be around $30,000, and costs tend to increase each year.

Fortunately, certain types of businesses, such as micro-businesses and home-based companies, have lower financial entry barriers. Here, we’ve put together a list of 14 different types of business startup costs you’ll need to consider when launching your company.

LLC Formation

How to calculate the cost of starting a business

Drafting a business plan is the best way to estimate your business startup costs. Within your plan, the financial projections section should estimate your revenue, profit, and expenses for the next three to five years.

There are other resources to estimate your finances as well, such as the SBA’s startup costs worksheet . Templates will help you estimate your initial investment costs, so you know how much capital you should request when you seek startup funding.

Keep in mind that many of the business startup costs we list below are recurring. You'll need to cover these costs over a monthly, quarterly, or annual basis — think rent, office supplies, and payroll. Other expenses, like the incorporation fee or office furniture, are one-time costs.

When calculating your business startup costs, a good rule of thumb is to be able to cover six months’ worth of expenses upfront. So don’t count on your business’s revenue to start easing your costs until at least after that early period is over. You’ll want a cushion while you get your feet under you and work on attracting business.

>> MORE: Best business budgeting tools

14 business startup costs to plan for

Although this is a typical list of business startup costs, your actual startup expenses depend entirely upon your specific business and industry.

Here are some typical business startup costs to plan for:

1. Equipment: $10,000 to $125,000

Almost every business will need to finance equipment immediately. Equipment costs for startups can range anywhere from $10,000 to $125,000, depending on the industry and size of the company.

For example, if you’re starting your own moving or shipping company, you’ll need to finance a truck. If you’re opening a restaurant, you’ll need commercial-grade ovens, stoves, dishware, and cooking utensils. If you own a hair salon, you’ll need styling chairs. And nearly any business will require computers.

Of course, these costs range according to your industry and the size of your business. Hiring employees will incur additional costs, as you may need to secure individual equipment, as well.

How much do you need?

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We’ll start with a brief questionnaire to better understand the unique needs of your business.

Once we uncover your personalized matches, our team will consult you on the process moving forward.

2. Incorporation fees: Under $300

One of your first to-dos when setting up a business is to choose a business entity, which has tax, legal, and financial implications.

If you decide to incorporate your business or form a limited liability company, you’ll need to file articles of incorporation or articles of organization, respectively, with your state. The filing fee can range from $50 to as high as $725 depending on the state. However, the fee is under $300 in the majority of states.

Even if you’re not incorporating, you’ll probably need to apply for federal or state licensing or permits. The types of documentation you'll need will vary based on your industry and location. For example, businesses within the agriculture or aviation sectors require federal licensing. Service-based sectors may need to have trade-specific licenses. And retail companies will likely need sales tax licenses or permits.

3. Office space: $100 to $1,000 per employee per month

Paying for an office or retail space will be a sizeable portion of your fixed costs, whether you rent or buy. You might spend between $100 per employee per month up to $1,000 per employee per month — again, it will depend on the type of space you're using.

You can mitigate these costs if you work from home in the beginning, or look into coworking spaces — both ideal for smaller businesses. And if you own a service-based business, you can travel directly to clients to further decrease overhead costs.

4. Inventory: 17% to 25% of your total budget

If you’re in the retail, wholesale, manufacturing, or distribution sector, you'll likely need to secure inventory to sell, as soon as you possibly can.

Knowing how much inventory to carry can be tricky: If you have too much inventory, you risk spoilage or damage. If you have too little, you risk losing customers who won't wait for items on backorder. This is especially true for seasonal businesses where inventory can vary drastically year-round.

You should allocate between 17% to 25% of your budget to inventory, depending on your industry. When you’re first starting out, consider securing more inventory. You'll want to attract customers and generate as much revenue as you can in your company's early stages.

5. Marketing: Below 10% of your total budget (even 0%)

Marketing materials might include physical materials, like signs, banners, and business cards. You might also consider paid ads, as well as more creative options, like videos and giveaways, that might require you to hire a consultant or a video producer.

Courtney Barbee, COO at The Bookkeeper, recommends keeping overall marketing costs to a minimum. Specifically, strive to keep your ad materials under 10% of your budget.

The good news? You can do the bulk of your small business marketing, for free. Thanks to social media and other online marketing strategies, advertising costs are often much lower for small businesses just starting now than they would have been 20 years ago.

6. Website: Around $40 per month

When building your business website, you'll want it to look professional, be easy to navigate, and display information about your services, products, hours, and contact information.

Fortunately, services like Wix, Squarespace, and Weebly, make creating a website easy and cost-effective. These content management systems are sometimes free, but premium plans will come at a monthly or yearly subscription cost:

Wix : $13 to $39 per month for a premium plan.

Squarespace : $12 to $18 per month billed annually, or $26 billed month to month.

Weebly : $5 to $25 per month.

Wix and Weebly also offer basic, free website builders. If you’re relatively tech-savvy, it’s easy to build a website through one of these services, no coding background required. But if you’re not very familiar with computers, you may want to hire someone to build the website — which, of course, is an additional cost (although it might become a worthwhile investment).

7. Office furniture and supplies: 10% of your total budget

Office furniture and supplies add up fast. If you’re operating in a traditional nine-to-five office environment, then every employee will need a desk, a chair, a computer, and a phone. Add in break room appliances, small office supplies, and computer programs, like your accounting software, and you’ll reach a hefty sum.

Again, that sum varies depending on the tools your business needs to operate, and the number of employees you need to outfit. Nate Masterson, the marketing manager at Maple Holistics, estimates that the total cost for office furniture and supplies would be around $5,000. In all, though, Masterson recommends keeping your furniture and supply costs to approximately 10% of your budget.

8. Utilities: Around $2 per square foot of office space

In addition to the fixed costs of rent and a down payment, you’ll be responsible for paying the electric, gas, water, internet, and phone bills for your office space. According to Iota Communications, the average cost of utilities for commercial buildings is $2.10 per square foot.

If you intend to install HVAC units, that will incur an additional cost — usually a couple of thousand dollars, not including installation fees and upkeep.

9. Payroll: 25% to 50% of your total budget

You need to pay your employees, even in the early stages, where you’re not bringing in much revenue. Remember, payroll includes all of the following:

Commissions.

Overtime pay.

Paid time off.

Of course, payroll costs will vary across startups. Typically, an employee will cost 1.25x to 1.4x their salary. For example, an employee on a $40,000 salary will actually cost you around $54,000 after factoring in various payroll tax costs and insurance.

A conservative payroll budget could work if you’re a sole proprietor, or if you’re running a small enterprise and use mostly 1099 contractors — and either is a pretty likely scenario for most startups.

10. Professional consultants: Between $1,000 and $5,000 per year

It’s tempting to take a DIY approach for all your business operations. After all, who knows your business best? But working with experts and professionals can be worth the investment.

For example, certified public accountants can explain the different legal structures, help you choose an employee benefit program, and ensure you're fulfilling your responsibilities as an employer. When tax season rolls around, they’ll prepare your tax returns and help you save on your taxes.

You don't need to hire a full-time accountant either. But it’s often a good idea to consult with your accountant on a monthly, quarterly, or annual basis to review your financial statements, and for general financial guidance and advice. Consulting with an attorney regularly can also save you from major legal mistakes like failing to trademark your logo or developing relationships with vendors without a contract in place.

Every CPA and lawyer charges different hourly rates. Rates and additional fees vary depending on the number and level of difficulty involved in the tasks you need outsourced, the time it takes to complete your projects, and your consultant’s tenure. However, you can mitigate these costs by taking on some basic tasks yourself, only outsourcing the most complicated projects. There are even some options to get free business legal advice.

And with the help of good business accounting software, you can handle basic bookkeeping, like processing and managing payroll, creating and tracking invoices, and managing your business bank account.

According to SCORE , all told, the majority of small business owners spend between $1,000 and $5,000 per year on administration tasks, including accounting and legal fees. But as a startup — and by taking advantage of those cost-cutting tactics we mentioned — you’ll probably err on the lower end of that spectrum.

11. Insurance: Average of $1,200 per year

Your business needs the same protections you provide to your health, home, and car. There are many different kinds of business insurance , including protection from customers that file a lawsuit against you and disaster insurance for potential fires that can shut down your restaurant for weeks.

The type of insurance your startup needs is entirely dependent on your business, industry, number of employees, and other risk factors. For instance, a sole proprietor running an online business has far fewer insurance requirements than a construction company with several employees.

Here are a few essential forms of insurance you should look into to protect yourself, and policy costs vary according to several different factors:

General liability insurance : About $400 to $800 per year. Your industry’s risk will be the most significant factor influencing the cost of your policy.

Commercial property insurance: Anywhere from $300 to $2,500+, depending on the value of the property and its assets, and a risk factor dependent upon the nature of the business and the location of the property.

Workers compensation insurance : Approximately $0.75 to $2.74 per $100 of payroll, depending on the business’s size, location, payroll, and risk.

Errors and omissions insurance: Approximately $2,000 to $5,000 per year, depending on your business’s size, industry, location, revenue, legal history, and the quality of your contracts and employee training procedures.

12. Taxes: Variable, but 21% corporate tax rate

When planning your budget, determining the exact amount to allocate toward business taxes can be confusing. It depends on your revenue (which is difficult to predict), your deductible expenses, and your business entity.

Under current federal law, corporations pay a flat 21% corporate income tax. For pass-through entities, business income and losses pass through to the owners' personal tax returns. Pass-through entities can claim a 20% deduction on income before paying their business taxes.

But know that you can often save money and time by working with a CPA. A skilled CPA will determine what you can deduct so that you pay as little as possible.

13. Travel: Variable

Not every new entrepreneur needs to factor travel into their business startup costs. But if you have a consulting business or you visit your customers directly, you will be traveling a lot. You'll need to factor in the price of transportation, food, and lodging — multiply these costs if you have multiple employees traveling. Be mindful of how quickly those costs add up.

Try to keep total travel costs to an absolute minimum so that you can allocate your revenue toward bigger expenses, like payroll and rent. And to make some returns on all that time on the road or in the air, consider using a travel business credit card, which can earn you points and miles for every dollar you spend. If you do have to travel frequently, keep the nonessentials like business class tickets to a minimum.

14. Shipping: Variable

Service-based businesses can probably stop reading here. But if you’re in retail, you might be shipping products to customers. If so, you’ll need to factor shipping into your startup costs, including packing materials and postage. Depending on what you’re sending, these costs can reach into the thousands of dollars.

Services like Stamps.com can ease the burden of shipping costs on small business owners. With this service, you can print postage without having to buy a costly postage meter. If possible, you can secure free or low-cost shipping boxes from your shipping service of choice.

How to save on startup costs

The costs of starting a business can certainly add up, with many expenses being non-negotiable. Do your research before you splurge on high-ticket purchases, and recognize that there are ways to take care of some of these startup costs on the cheap.

For example, using software like QuickBooks can save on the costs of hiring a professional bookkeeper. Working from home or using a coworking space is a cost-effective alternative to leasing office space. And leveraging social media can mitigate your marketing costs.

Some costs are worth the investment. Don’t buy poor-quality equipment just because it’s cheaper — you’ll lose time and money making repairs and eventually need to purchase new equipment. Hire a legal or accounting expert if you’re confused. And make sure your website and advertising campaigns are professional-looking and effective.

Secure funding

If you've calculated your business startup costs and now feel overwhelmed, know that there are plenty of resources to help you find startup financing.

Your initial funding will likely come from a combination of debt and equity financing. But keep in mind that debt financing options — small-business loans — are relatively limited for brand-new businesses. Most lenders only feel comfortable offering loans to established companies with hard evidence of profitability, as well as healthy credit, which most startups simply don’t have yet.

Some lenders work with startup business owners, so don’t completely rule it out if you think it’s your best option. Check out more information on how to get a loan to start a business if you think debt financing is the right move for you.

» MORE: What is a business loan?

Get a business credit card

Once you’ve established a legal entity for your business, we recommend applying for a business credit card.

The application is simple, and a business credit card is usually easier to qualify for than a traditional business loan. Also, you typically gain access to a higher credit limit than your personal card. More importantly, a business credit of card keeps your personal and business finances separate — essential if you wish to maintain your personal liability protections after forming an LLC or corporation.

» MORE: What is a business credit card?

Just make sure you’re not maxing out your credit card or charging more than you can repay. Both can harm your credit score, which might hurt your chances of securing a small business loan down the line.

Frequently asked questions

1. what is the average cost to start a small business.

The cost of starting a small business depends on the type and size of the business you’re opening and your industry. For example, opening a McDonald’s franchise can cost you $1 million, while starting a social media consulting company may cost less than $10,000. The average cost will vary on a case-by-case basis.

2. How do you calculate startup costs?

The most straightforward method for calculating your startup costs is to use a budget template. Your budget will break down your startup costs and recurring expenses — rent, office supplies, payroll, and more.

It’s prudent to cover six months’ worth of expenses minimum upfront; this financial cushion will support you in your business’s early stages when your profit margins might be slim.

3. Are business startup costs tax-deductible?

While the IRS does not recognize startup costs as capital expenditures, they do state that you can deduct $5,000 of business startup and $5,000 of organizational costs paid or incurred after October 22, 2004, but only if your total startup costs are $50,000 or less.

You can review IRS Publication 535 or consult a business accountant for additional information.

4. What is considered a startup cost?

A startup cost is any expense incurred when starting a new business. Startup costs will include equipment, incorporation fees, insurance, taxes, and payroll.

Although startup costs will vary by your business type and industry — an expense for one company may not apply to another. For example, a brick-and-mortar business will need to pay to rent a separate business location, unlike a home-based online consulting company.

This article originally appeared on JustBusiness, a subsidiary of NerdWallet.

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How to estimate figures for your business plan

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Alex is a digital entrepreneur and business consultant specialising in start-ups and digital media. He is the CEO of Hyperlink Media, a digital agency based in London.

Creating a business plan brings some specific challenges, especially around predicting cash flow, sales and costs. How can you get accurate figures for your plan when you’re starting from scratch?

Here’s some tips on estimating the financials for your business plan, to ensure it’s as useful as possible.

Business plan financials

There are several areas that you’re likely to need for your plan. These are:

• Sales forecast
• A simple profit and loss
• What funds are available, and any finance needed

How to estimate your figures

Many people feel intimidated by the financial side of business planning . Jennifer O’Toole, Senior Partner at accountancy firm Thomas R Dixon, acknowledges that “it can often be difficult to predict sales & costs if you have nothing to work from but it’s not impossible.”

Remember that it won’t be perfect, but if you can estimate fairly accurately it will be helpful – and can save any nasty shocks later. So where should you get the data? Jennifer says, “Look for information in the public domain such as competitors’ accounts to give you examples of sales/costs/ratios that are relevant to your market”.

You can access these via websites like Company Check , which allows you to download up to 100 sets of company accounts for free each month.

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What to focus on for each section

Once you have an idea of where to go for some raw data, you’ll need to begin to apply the figures to your prospective business.

Key things to consider when calculating your… sales

This is a key measure for your business and its success. Your sales forecast should show a month-by-month breakdown for the next 12 months and then an annual overview for the two years following.

There are a number of ways to calculate your sales but the following approach can be useful:

• List each of your products or services
• Work out the price for each of those products or services
• Think about the market and how many sales you may achieve each month. This might be as a percentage of capacity (e.g. available hours or tables occupied in a restaurant) or as a number of units. Remember that you won’t be at capacity all the time (if at all).
• Allow time to get established – it may take you some time to get your first sales or you may have an initial flurry of sales from your first contacts, followed by a quieter period.
• Consider seasonal effects on each type of sales or service. This doesn’t just happen for people selling deckchairs and Christmas trees. For example, if you sell to businesses, you may find sales drop during the summer and over Christmas as people are on holiday.
• If you have a new product, look at sales figures for similar types of products.

…costs

Every business has costs, either to produce the products, to buy in materials or to manage overheads. You need to estimate these costs in your plan.

• Work out what costs you will have
• Do some research into what prices you may need to pay. Remember that as a new business, you may be charged a higher amount than more established companies.
• Buying in bulk can lower costs, but you need the cash to be able to do this and it ties up your money in stock.

Your costs should have a month-by-month breakdown for the next 12 months and show annual figures for the two years following.

…cash flow

Your cash flow forecast will show when the money comes in and goes out. Once you have your sales and costs figures, you’re part of the way there. However, do remember:

• You may not get paid for a sale when you make it. Factor in time for people to pay invoices – and the unfortunate reality that some of these will be paid late.
• You may be able to get credit with your suppliers, which can delay when the costs affect your cash flow. However, some small businesses can’t get credit when they first start, so check with your prospective suppliers to see what terms may be available.

Once you have that information, you can create your monthly cash flow forecast for the next two years.

…and profit and loss

This will show all of the income and expenditure for your business and should cover at least two years. In addition to your sales and costs data, it will show any income other than sales, together with costs such as marketing, fees, salaries, travel, rent, insurance, etc.

Keep it realistic

Some business plans contain figures that are clearly unachievable. If you’ve watched Dragons’ Den you’ll see that this can be a common scenario. Most entrepreneurs are optimistic people, so they can get carried away with their numbers. It pays to err on the side of caution as the income pays for your day-to-day living expenses and the future of your business.

Jennifer says, “Be realistic about your abilities and that of your team. It can often be demotivating to set targets that are unobtainable; that said you need to set goals that ‘raise the bar’.”

• You won’t capture the whole market
• It takes time to build up a business
• You won’t win all work you pitch for

Look at your figures again and ask yourself if they are achievable. If you’re unsure, your accountant may be able to offer some advice.

Getting the finance in place

Of course, access to good figures also gives you an indication of how much capital you might need and how long it will be before your business is profitable.

Some businesses “bootstrap” their launch and make use of owners’ savings to get started. For others, they will need funding.

If you are looking for investment , it’s important that you know what your numbers are – not only what you’re looking for but also how the money will be used and when investors can see a return. You should know your figures inside out as this will show confidence and an understanding of your business.

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Thinking of starting a business or looking for investment but need help putting a plan together? Get our free, easy-to-use business plan template.

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Understanding Common Business Startup Costs

Additional startup cost considerations, the bottom line.

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How to Estimate Business Startup Costs and What It Covers

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Starting a business involves much more than just setting up an office or choosing furnishings. It demands careful financial planning and precise accounting, particularly in the initial stages.

Many new businesses make the mistake of not properly estimating and budgeting for startup costs, relying too much on a sudden influx of customers. This approach often leads to poor results and even the business's failure . A solid financial plan is key not only for managing startup costs but also for building a foundation for your venture's future growth.

Key Takeaways

• Startup costs are expenses incurred while establishing a new business. They can be divided into two categories: pre-opening and post-opening. 
• Pre-opening startup costs include a business plan, advertising, employee training, professional services, and setting up books and records.
• After the business opens, costs shift toward advertising, promotional activities, and employee salaries.
• Different types of business structures—like sole proprietorships, partnerships, and corporations—each have unique startup costs. Understanding these variations is crucial as you plan your budget and financial strategy.

Startup costs are the expenses a new business faces during its creation. Unfortunately, starting a business with no money is challenging and not an option for most businesses, which will require capital to start operations. Each business is unique and thus incurs different types of startup costs depending on its nature of operations.

For example, online businesses, such as e-commerce websites, often have lower initial capital requirements than brick-and-mortar businesses, such as restaurants. This difference in startup costs may stem from online businesses needing less physical space, fewer furnishings, and often fewer staff compared to brick-and-mortar operations.

Despite these differences, several expenses are common across most types of businesses. These typically include costs related to legal or attorney fees, licensing, initial inventory, market research, and marketing efforts to launch the brand.

Keep detailed records of all your startup expenses from the beginning. This not only helps with budgeting and planning but also ensure you can take full advantage of any tax deductions available for startup costs.

The Business Plan

Creating a business plan is crucial for starting a business as it provides a detailed roadmap and prompts careful consideration of various startup costs. Underestimating these expenses can lead to an inflated expectation of net profit, which can be detrimental for a small business owner. Hiring a consulting firm or a business plan writer to assist with creating a business plan can cost between $1,000 and $5,000 or more. The final price often depends on the complexity and length of the plan.

Research Expenses

Before launching a business, it's crucial to thoroughly research the industry and target consumer demographics. Some business owners opt to hire market research firms for this purpose.

Hiring a market research firm is essential for companies wanting to excel in competitive markets. These firms offer key insights into customer preferences and industry trends, using both qualitative and quantitative data to inform strategies ranging from product development to marketing. Their analysis helps businesses make informed decisions and identifies potential risks and opportunities.

For business owners who choose to follow this route, the expense of hiring these experts must be included in the business plan.

Borrowing Costs

Starting up any kind of business requires an infusion of capital. There are two ways to acquire capital for a business: equity financing and debt financing. Equity financing usually entails the issuance of stock, meaning the company offers shares of its ownership to investors in exchange for funds. However, this doesn't apply to most small businesses, which are proprietorships and don't issue stock.

For small business owners, the most likely source of financing is debt in the form of a small business loan . Business owners can often get loans from banks, savings institutions, and the U.S. Small Business Administration (SBA). Like any other loan, SBA business loans come with principal and interest payments that need to be carefully planned for when starting a business, as failing to make these payments can result in severe consequences.

Insurance, License, and Permit Fees

Many businesses are expected to submit to health inspections and authorizations to obtain certain business licenses and permits. Some businesses might require basic licenses while others need industry-specific permits.

Carrying insurance to cover your employees, customers, business assets, and yourself can help protect your personal assets from any liabilities  that may arise. 

Technological Expenses

Technological expenses include the cost of a website, information systems, and software, including accounting and point of sale (POS) software , for a business. Some small business owners choose to outsource these functions to other companies to save on payroll and benefits.

Equipment and Supplies

Every business needs equipment and basic supplies, which are crucial components of startup costs. When planning these expenses, you must decide whether to lease or buy the equipment. 

The state of your finances will play a major part in this decision. Even with sufficient funds to purchase equipment outright, it might be more practical to lease initially, with the option to buy later, especially if other unavoidable expenses arise. However, it's important to remember that, regardless of the cash position , leasing isn't always the most beneficial option depending on the type of equipment and the lease terms.

Advertising and Promotion

A new company or startup business is unlikely to succeed without promoting itself. However, promoting a business entails much more than placing ads in a local newspaper.

It also includes marketing —everything a company does to attract clients to the business. Marketing has become such a science that any advantage is beneficial, so external dedicated marketing companies are most often hired.

Employee Expenses

Businesses planning to hire employees must plan for wages, salaries, and benefits, also known as the cost of labor . This includes not only direct payments but also any additional benefits that contribute to employee compensation packages, including health insurance, retirement plans, and bonuses.

Failure to adequately compensate employees can result in low morale, mutiny, and bad publicity, all of which can tarnish a company's reputation and be disastrous for the business.

Set aside some extra money for any overlooked or unexpected expenses. Most companies fail because they lack the cash to deal with unexpected problems during the business season.

It's important to note that the startup costs for a sole proprietorship differ from the startup costs for a partnership or corporation. Some additional costs a partnership might incur include the legal cost of drafting a partnership agreement and state registration fees.

Other costs that may apply more to a corporation include fees for filing articles of incorporation, bylaws, and terms of original stock certificates.

What Are Business Startup Costs?

Startup costs are the expenses required to create a new business. Once the business is operational, these costs can be broadly categorized into pre-opening and ongoing or operating expenses . Pre-opening costs may include expenses for developing a business plan, market research, securing a location, and initial marketing. Ongoing costs typically involve operational expenses like employee salaries, utilities, and inventory replenishment.

What Business Startup Costs are Tax Deductible?

Tax-deductible startup costs generally include essential expenses for establishing a new business, such as market research, opening advertisements, and employee training salaries. The IRS allows new businesses to write off startup expenses of $10,000 in startup costs and $5,000 in organizational costs in the year the business begins. However, total startup costs must be $60,000 or less and organizational costs must be $50,000 or less. If the costs exceed the maximums, the remaining has to be amortized.

How Do I Calculate Business Startup Costs?

To calculate your startup costs, first identify all necessary expenses like office space, equipment, licenses, permits, salaries, and marketing. Estimate each expense by researching online and consulting with mentors or similar businesses. You can then organize these costs into one-time and monthly categories, then calculate a total to understand your capital needs. Calculating your expected startup costs can help you secure funding, attract investors, and launch your business successfully.

Understanding and planning for startup costs is crucial for any new business. These costs include pre-opening expenses, like market research and business plans, and post-opening expenses, such as marketing and employee salaries. Every business has unique costs, but common expenses often involve legal fees, permits, equipment, and technology.

Accurately estimating your startup costs is key for any new founder. Realistic figures can help secure funding from investors or banks and ensure smooth operations. Keeping detailed records from the start can also help you in financial planning and maximizing tax benefits.

Internal Revenue Service. " Why Should I Keep Records? "

PlanBuildr Business Plan Software. " How Much Does a Business Plan Cost? "

U.S. Small Business Administration. " Fund Your Business ."

Internal Revenue Service. " Publication 583, Starting a Business and Keeping Records ." Pages 9-10.

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Home > Financial Projections > Cost Structure in a Business Plan

Cost Structure in a Business Plan

What is cost structure.

Financial projections need to take account of the cost structure of a business. Cost structure simply refers to the split between variable costs and fixed costs, but can have a significant impact on whether a new start up business is successful or not.

Fixed and Variable Costs

First a few definitions. A variable cost is a cost which changes in direct proportion to any production or selling activity, examples include, direct materials and labor used in manufacture, product cost, and sales commissions. On the other hand, a fixed cost is a cost which will occur whether or not a business has any production or selling activity. Fixed costs are a function of the passage of time, examples include rent, salaries, and insurance.

Low Fixed Cost Structure or High Fixed Cost Structure?

Although the cost structure of a business is to some extent fixed by the nature of the business and the type of industry in which it operates, decisions can be taken to directly influence the split between fixed and variable costs. It is important to understand that a business can have the same sales, total costs and therefore profit, but a completely different costs structure, as seen in the diagrams below.

Both businesses have the same sales, total costs, and profit, however, the first business has a high fixed cost structure compared to the low fixed cost structure of the second business.

Business Plan Cost Structure and Break Even

Consider as an example the two start up businesses shown in the table below. The financial projections of the first business show a high fixed cost structure. the business plans to start by investing heavily in production facilities, machinery and equipment to manufacture and distribute its own product. The consequence of this decision is high fixed costs but lower variable costs.

The second business proposes a lean start up. It plans to have the manufacture and distribution outsourced to a third party, its needs smaller premises and less investment in machinery and equipment and therefore has lower fixed costs but correspondingly higher variable costs, as payments need to be made to the third parties for manufacture and distribution.

Effect of Cost Structure on Break Even Calculations

In each case, the number of units sold (6,000), selling price (12,00), total costs (65,000), and profits (7,000) are identical. Using this information and the break even formula, the break even point can be calculated for each of the start up businesses.

The break even formula is:

and the break even units are given by the formula:

The results of the calculations using the formulas are summarized in the table below.

We can see that even though everything else is the same, the financial structure of the business has resulted in a completely different break even position.

For the low fixed cost structure business, only 3,083 units need to be sold at 12.00 to reach break even as shown in the diagram below.

In contrast for the high fixed cost business 5,028 units need to be sold to reach break even as indicated in the diagram below.

In order to break even, the high fixed cost business needs to sell 1,945 (63%) more units than the low fixed cost business.

The conclusion is that when producing financial projections for a start up business, in order to reduce the break even point to an acceptable level, the cost structure should aim to keep the fixed costs as low as possible.

About the Author

Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

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How to Calculate Production Costs: A Comprehensive Guide

August 26th, 2024

In the manufacturing industry, calculating production costs accurately is crucial for the success and profitability of a business. Understanding production costs allows companies to make informed decisions, set competitive prices, and identify areas for cost reduction. In this comprehensive guide, we will dive into the definition of production costs, examine their components, explain the steps to calculate them, analyze the results, and highlight common mistakes to avoid.

Understanding Production Costs

Definition of production costs.

Production costs refer to the expenses incurred by a company during the manufacturing process of a product. These costs include direct materials, direct labor, and manufacturing overhead. Indirect costs, such as utilities and facilities maintenance, also contribute to the overall production costs.

Direct materials are the raw materials or components that are directly used in the production of a product. These can include items like wood, metal, plastic, or any other material that is transformed into the final product.

Direct labor refers to the wages and benefits paid to the workers who are directly involved in the manufacturing process. This includes the time and effort spent by individuals in assembling, operating machinery, or performing any other tasks required to produce the product.

Manufacturing overhead encompasses all the other costs that are not directly tied to the materials or labor. These can include expenses like rent for the production facility, equipment maintenance, utilities, insurance, and other administrative costs.

Importance of Calculating Production Costs

The ability to accurately calculate production costs is essential for various reasons. Firstly, it helps businesses determine the cost effectiveness of their operations. By understanding the costs associated with production, companies can assess their profitability, identify areas where costs can be reduced, and improve their overall financial performance.

For example, by analyzing the production costs, a company may discover that a particular material is more expensive than alternatives in the market. This knowledge can prompt them to explore other suppliers or materials that can help reduce costs without compromising the quality of the final product.

Secondly, calculating production costs allows companies to set competitive prices for their products. By considering the expenses incurred during the manufacturing process, businesses can establish prices that not only cover their costs but also remain attractive to customers.

Understanding the production costs helps companies strike a balance between profitability and market competitiveness. By accurately assessing the costs, businesses can avoid underpricing their products, which would result in losses, or overpricing them, which could lead to a loss of customers to competitors.

Lastly, understanding production costs aids in the decision-making process. It assists in evaluating whether it is financially viable to introduce new products, make changes to the manufacturing process, or expand production capacity.

By analyzing the production costs, companies can determine the potential return on investment for new product development. They can also assess the feasibility of implementing process improvements or expanding production facilities, taking into account the additional costs involved and the potential increase in revenue.

In conclusion, production costs play a crucial role in the success of a company. By accurately calculating these costs, businesses can make informed decisions, improve profitability, and ensure competitiveness in the market.

Components of Production Costs

When it comes to understanding the intricacies of production costs, it is important to break it down into its various components. By doing so, businesses can gain a comprehensive understanding of the expenses involved in the manufacturing process. Let's delve deeper into the three key components of production costs: direct materials, direct labor, and manufacturing overhead.

Direct Materials

Direct materials encompass the tangible inputs used in the manufacturing process. These materials directly contribute to the final product and can include raw materials, parts, and components. Without these essential materials, the production process would come to a halt. Calculating direct material costs involves determining the quantity of materials used and multiplying it by their respective unit costs. This calculation ensures that businesses have a clear understanding of the expenses incurred in acquiring the necessary materials for production.

Direct Labor

Direct labor refers to the wages paid to employees directly involved in the production process. These individuals play a crucial role in transforming the raw materials into the finished product. Whether it's operating machinery, assembling components, or performing quality control checks, the efforts of the direct labor force are invaluable. To calculate direct labor costs, businesses multiply the total number of hours worked by the employees involved in production by their respective hourly wage rate. This calculation allows for an accurate assessment of the labor expenses incurred during the manufacturing process.

Manufacturing Overhead

Manufacturing overhead incorporates indirect costs that cannot be directly attributed to a specific product but are essential for the production process. These costs include utilities, maintenance, depreciation of equipment, factory rent, and other miscellaneous expenses. While these costs may not be directly tied to a single product, they are crucial for the overall functioning of the manufacturing facility. To calculate manufacturing overhead costs, a predetermined overhead rate is determined and applied to the estimated activity base for the manufacturing process. This calculation helps businesses allocate the indirect costs in a fair and accurate manner.

Understanding the components of production costs is vital for businesses aiming to optimize their manufacturing processes. By analyzing the direct materials, direct labor, and manufacturing overhead, companies can identify areas for cost reduction, improve efficiency, and make informed decisions to enhance their bottom line.

Steps to Calculate Production Costs

Calculating production costs is an essential task for any manufacturing business. By accurately determining the costs involved in the production process, companies can make informed decisions about pricing, profitability, and cost-saving measures. The process of calculating production costs involves several steps, including identifying direct materials costs, calculating direct labor costs, and determining manufacturing overhead costs. Let's explore each of these steps in detail.

Identifying Direct Materials Costs

Direct materials costs refer to the expenses incurred for the materials directly used in the manufacturing process. To identify these costs, start by gathering information on the quantity of materials used. This data can be obtained from production records, inventory data, or purchase records. It is crucial to have accurate and up-to-date information on the quantity of each material used.

Once you have the quantity data, the next step is to multiply the quantity of each material used by its unit cost. This will give you the total cost of direct materials. It is important to consider any additional costs associated with the materials, such as shipping or handling fees, to ensure an accurate calculation.

By identifying direct materials costs, businesses can have a clear understanding of the expenses incurred for the raw materials used in their production process. This information can help in negotiating better deals with suppliers, optimizing inventory management, and making informed decisions regarding material sourcing.

Calculating Direct Labor Costs

Direct labor costs are the expenses associated with the employees directly involved in the production process. Calculating these costs requires determining the total number of hours worked by each employee and multiplying it by their respective hourly wage rates.

To gather the necessary data for calculating direct labor costs, businesses can rely on employee time cards or work logs. These records should accurately reflect the hours worked by each employee on production-related tasks. It is important to consider any overtime hours or additional compensation rates when calculating direct labor costs.

Once you have the total number of hours worked by each employee, multiply it by their respective hourly wage rates. Sum up the direct labor costs for all employees to arrive at the total direct labor cost. This figure represents the expenses incurred for the labor directly involved in the production process.

Calculating direct labor costs provides businesses with insights into the labor expenses associated with their production process. This information can be used to evaluate labor productivity, identify areas for improvement, and make informed decisions regarding workforce management.

Determining Manufacturing Overhead Costs

Manufacturing overhead costs are the expenses that cannot be directly attributed to specific units of production but are necessary for the overall manufacturing process. Determining these costs requires establishing a predetermined overhead rate based on the estimated activity level for the production process.

The predetermined overhead rate is calculated by dividing the estimated total manufacturing overhead costs by the estimated activity level. The activity level can be measured in various ways, such as direct labor hours, machine hours, or production units. It is essential to choose an appropriate activity level that accurately reflects the manufacturing process.

Once the predetermined overhead rate is established, it is applied to the actual activity level to determine the manufacturing overhead costs. This calculation helps in allocating the overhead expenses to the units of production. It is important to periodically review and adjust the predetermined overhead rate to ensure accuracy.

Comparing the calculated manufacturing overhead costs with the actual overhead expenses is crucial to ensure accuracy in cost calculations. Any significant variances should be investigated to identify the reasons behind them and take corrective actions if necessary.

By determining manufacturing overhead costs, businesses can have a comprehensive understanding of the indirect expenses associated with their production process. This information can be used to evaluate cost efficiency, identify areas for cost reduction, and make informed decisions regarding overhead allocation.

Analyzing Production Cost Results

Interpreting your production cost calculations.

Once the production costs are calculated, it is essential to interpret the results to gain valuable insights. Analyze the cost breakdown of direct materials, direct labor, and manufacturing overhead to identify areas of potential cost reduction. This analysis will help optimize processes, reduce waste, and improve overall efficiency.

Strategies for Reducing Production Costs

Reducing production costs requires a proactive approach and strategic decision-making. Some effective strategies include optimizing inventory management, streamlining the production process, negotiating better prices with suppliers, investing in automation, and continuously improving efficiencies. By implementing these strategies, businesses can enhance their cost competitiveness and increase their profitability.

Common Mistakes in Calculating Production Costs

Overlooking indirect costs.

One common mistake in calculating production costs is overlooking indirect costs. These costs, such as utilities, maintenance, and depreciation, are often not allocated properly. Failing to include these expenses in the calculations can lead to inaccuracies and distortion of the true production cost.

Misclassifying Expenses

Another common mistake is misclassifying expenses. It is important to correctly categorize expenses as either direct or indirect costs to ensure accurate calculations. Misclassifying expenses can result in incorrect cost allocations and a skewed understanding of the production costs.

In conclusion, understanding and accurately calculating production costs are vital for the success of manufacturing businesses. By grasping the definition of production costs, identifying their components, following the steps to calculate them, and avoiding common mistakes, companies can make informed decisions, set competitive prices, and optimize their operations. Remember, the per-unit product cost can be obtained by dividing the total production cost by the number of units manufactured. With this comprehensive guide, you are now equipped to navigate the complex world of production cost calculations.

Breaking Down Production Costs: A Guide for Small Businesses

Unlock smarter pricing and profitability with our guide to understanding all your production costs—simplified. 💡📈

Introduction

If you're serious about running a sustainable and profitable business, having a thorough grasp of your production costs is non-negotiable. In this guide, we'll simplify the complexities of direct, indirect, and overhead costs for you, demonstrating why understanding these elements is vital for your business's success.

1. What Are Production Costs?

Production costs are the expenses you incur to create a product or deliver a service. These costs directly affect your pricing strategy, profitability, and even your business's scalability. Think of them as the ingredients needed to make the perfect cake—or in your case, the perfect product or service.

2. Types of Production Costs

Direct costs.

Direct costs are those expenses that are directly tied to the production of your goods or services—think raw materials and labor. For instance, if you run a bakery, the cost of flour, sugar, and labor are your direct costs. Get this wrong, and you could either be overcharging your customers or, worse, losing money on every sale.

Indirect Costs

Unlike direct costs, indirect costs are not directly linked to production. These include utilities, rent, and maintenance. Let's say you have a co-working space where you rent out desks. The electricity bill for the entire floor is an indirect cost that needs to be allocated to each rentable desk to determine its profitability.

Overhead Costs

Overhead costs are a subset of indirect costs that keep your business running but don't directly contribute to earnings—like administrative expenses, marketing, and sales. There is a difference between manufacturing and administrative overhead. Manufacturing overhead includes costs like factory upkeep, while administrative overhead involves costs like office supplies for the management team.

3. Calculating Production Costs

Navigating the costs of production doesn't have to be daunting. By systematically breaking down the various components, you can arrive at a clear understanding of your total expenses. Here's a step-by-step guide to help you calculate production costs with illustrative examples:

• Identify Direct Costs These are costs that go directly into the production of your goods or services. For instance, if you own a bakery, the flour and sugar needed to make cakes would be direct costs.

Example : In a bakery, $50 for flour and $20 for sugar for one batch of cakes.

• Identify Indirect Costs :These are ongoing expenses that support your business but are not directly related to the production of individual products.

Example : The monthly electricity bill of $300 for running your bakery's ovens and lighting.

• Identify Overhead Costs : These are additional expenses necessary for the overall operation of your business, like administrative salaries, marketing, and utilities.

Example : $1,000 for marketing and $500 for administrative salaries in a month.

• Allocate Costs :Here, you'll distribute your indirect and overhead costs over your total number of products to get a cost-per-item. Different businesses use different allocation methods.

Example : If your bakery produces 1,000 cakes a month, and the total indirect and overhead costs are $1,800, then each cake carries an additional cost of $1.80.

• Total Up :This is where you sum up all the costs—direct, indirect, and overhead—to arrive at the total production cost per item.

Example : For each cake, add the cost of flour ($50), sugar ($20), indirect costs ($1.80), and overhead costs ($1.80) to get a total cost of $73.60.

By following these steps, you'll gain a better understanding of your production costs, which in turn will help you set appropriate pricing and make more informed business decisions.

To provide a clearer illustration, let's look at the production cost for making a batch of cakes in a bakery.

ItemCostFlour$50Sugar$20Electricity (Indirect Cost)$0.30Administrative Salary (Overhead)$0.50Marketing (Overhead)$1.00Total Cost per Cake$73.60

By breaking down the costs, you can see where your money is going and how each type of expense contributes to the total cost of producing a batch of cakes. This itemized list makes it easier to understand your production costs, helping you make more informed decisions for your business.

4. Bill of Materials: Your Production Recipe

Think of a Bill of Materials (BOM) as the recipe for your product. This comprehensive list outlines all the materials, ingredients, and other resources you need to create a product.

In our bakery example, the BOM would list out the exact type and amount of flour, sugar, and any other ingredients you'd need. A well-crafted BOM is essential for accurately allocating direct, indirect, and overhead costs, enabling you to pinpoint the total production cost per batch.

Cake Bill of Materials (BOM)

ItemMaterial/IngredientQuantityUnit Cost ($)Total Cost ($)FlourAll-Purpose10 lbs5.0050.00SugarGranulated4 lbs5.0020.00ElectricityUtilityPer batch0.300.30Administrative SalaryOverheadPer batch0.500.50MarketingOverheadPer batch1.001.00Total Cost per Batch72.80

This BOM outlines the costs involved in producing a single batch of cakes. While it focuses mainly on direct material costs, it also accounts for a simplified view of indirect and overhead costs to give a holistic understanding of production costs.

By understanding your Bill of Materials, you can identify areas for cost reduction, more efficient sourcing of materials, or optimization of production processes.

5. Cake Production Cost: A Complete Example

Ready to see how it all comes together? Let's walk through a real-life example of how to calculate the total cost of making a cake. We'll break down each type of cost—materials, labor, and those extra overhead expenses—to show you just how they all add up. This way, you'll know exactly where your money's going and maybe even find a few ways to save.

Direct Material Costs (BOM)

ItemMaterial/ComponentQuantityUnit Cost ($)Total Cost ($)FlourAll-purpose2 cups0.501.00SugarGranulated1 cup0.400.40EggsLarge30.200.60ButterUnsalted1 stick0.800.80Total Direct Material Cost2.80

Direct Labor Costs

TaskLabor TypeTime (hrs)Hourly Rate ($)Total Cost ($)MixingBaker0.515.007.50BakingBaker1.015.0015.00DecorationDecorator0.512.006.00Total Direct Labor Cost28.50

Indirect Costs (Overhead)

Overhead TypeAllocation MethodCost ($)RentPer cake2.00UtilitiesPer cake1.00Equipment DepreciationPer cake0.50Total Indirect Cost

Final Calculation: Complete Cost Breakdown

Cost ComponentCost ($)Total Direct Material Cost2.80Total Direct Labor Cost28.50Total Indirect Costs3.50Total Production Cost34.80

By adding up these components, you'll find that the total production cost for a single cake is $34.80.

This detailed breakdown helps you fully understand where your production costs are going, an essential part of running a successful cake-making business.

6. Importance of Understanding Production Costs

While it may seem straightforward, the significance of fully grasping your production costs can't be overstated. This isn't just a matter of setting the right price for your product; it's an essential foundation for your entire business strategy. Here's why:

• Pricing Strategy First and foremost, understanding production costs is crucial for setting a price that not only covers these costs but also leaves room for profit. Price too low, and you could be operating at a loss; price too high, and you might drive away potential customers.
• Budgeting and Financial Planning By breaking down each element of your production costs, you can create a more accurate and flexible budget. This aids in financial planning and helps you to allocate resources more effectively. In the long term, this can lead to greater profitability and less financial stress.
• Competitive Edge Knowing the nitty-gritty of your production costs also gives you a competitive advantage. It allows you to identify areas for cost-saving, whether that's in sourcing cheaper materials without sacrificing quality or streamlining your production process. These savings can either boost your bottom line or be passed onto the customer, making your products more attractive in a competitive market.
• Decision-Making With a deep understanding of production costs, you're better equipped to make informed decisions. Whether it's deciding to introduce a new product line, scale production, or even exit a market, you'll be making choices based on solid financial understanding rather than guesswork.

So, as you can see, getting a handle on production costs isn't just a numbers game—it's a pivotal part of your broader business strategy.

7. Production Costs and Break-even Analysis

The concept of a "break-even point" might sound like jargon, but it's a critical milestone that every business, big or small, aims to reach. Simply put, the break-even point is the moment when your total revenue equals your total costs—meaning you're not losing money, but you're not making any either. Here's why understanding your production costs is pivotal for this key business metric.

• The Role of Production Costs in Break-even Analysis Knowing the specifics of your production costs is the first step to accurately calculating your break-even point. The idea is to find out how many units of your product you must sell to cover all your costs. The more accurately you've calculated your production costs, the more precise your break-even point will be.
• Why Break-even Analysis Matters Reaching the break-even point is essentially the first sign of business sustainability. From there on, each additional unit sold is pure profit. But if you don’t know your production costs, you can't accurately determine when you'll start making a profit. That makes break-even analysis not just a nice-to-know, but a must-know for business owners.
• Dynamic Monitoring Your break-even point isn't set in stone. As production costs change due to fluctuating material prices, labor rates, or overhead costs, so will your break-even point. Continuous monitoring and updating of your production costs will allow you to adjust your break-even calculations, helping you stay on track toward profitability.
• Decision Making and Strategy An accurate break-even analysis can inform various strategic decisions, such as setting sales targets, pricing strategies, and marketing campaigns. It's an invaluable tool for evaluating the financial viability of new projects or product lines, helping you decide whether to go ahead or reconsider.
• Limitations and Considerations While break-even analysis is a helpful tool, it's important to remember that it simplifies a complex reality. For example, it assumes that all units are sold at the same price and that costs are constant, which may not always be the case. However, knowing your production costs makes these calculations more reliable, even if they are approximations.

In summary, understanding your production costs plays a fundamental role in calculating your break-even point, which is integral to strategic planning and long-term business sustainability.

Getting a handle on your direct, indirect, and overhead costs is more than just smart—it's essential for your business to thrive. It influences your prices, your profits, and even your future plans. So take the time to get it right, and you'll be setting yourself up for success.

Stressed about juggling all those production costs? Let Cashflow's simple, cloud-based accounting tools do the heavy lifting. Our user-friendly Production Order feature keeps tabs on all your costs, so you can put your energy into growing your business instead. Give Cashflow a try and make your life easier!

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Business Startup Costs: How To Calculate And Budget

Updated: Jan 6, 2022, 9:00am

Starting a business comes with a variety of costs, which may require you to seek external business financing. In fact, entrepreneurs file millions of business applications every year in the U.S. The number of new business applications surged to a record 4.5 million in 2020, according to the Economic Innovation Group.

If you’re working to get your own business up and running, it’s crucial to understand the different costs you might encounter. Knowing potential business startup costs upfront makes you better prepared as an entrepreneur and can improve your odds of success.

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How to Calculate the Cost of Starting a Business

There’s no set cost to start a business —many factors can impact your initial startup expenses. In some cases, you might be able to get a company off the ground with a few thousand dollars. Other small business owners might need to come up with five figures (perhaps several times over) during their first year in operation.

With such a wide range of potential expenses, it’s helpful to start with a business plan. A separate startup cost analysis can help you estimate your costs as well. The U.S. Small Business Administration (SBA) provides free guidance and sample worksheets you can use for both.

• SBA Sample Business Plans
• SBA Startup Cost Worksheet

Taking the time to write out (and add up) your initial startup costs is a smart move. This extra preparation on the front end can lead to more realistic expectations and better long-term results for your new business endeavor.

Common Business Startup Costs

Go through the common business startup costs below to determine which expenses your business might encounter.

Incorporation Fees ($145)

One of the first tasks you’ll need to complete when you form a new business is choosing a business entity. General business structure choices include:

• Sole proprietorship
• Partnership
• Corporation
• Limited Liability Company (LLC)

The average cost to register a business is $145. However, filing fees and other associated costs can differ based on the state where you operate.

Research Expenses ($100–$30,000+)

Researching the market you plan to enter puts your business in a better position to succeed. Some entrepreneurs attempt to do this research on their own. However, hiring a professional market research firm could give you a clearer picture of the industry, your target customers and your competition.

The price of market research can vary depending on the type of report and guidance you require. High-level market overviews might cost a few hundred to a few thousand dollars. A more detailed and personalized project by comparison could cost at least $30,000.

Equipment ($11,000–$125,000)

Regardless of your type of business, it probably needs some type of equipment to operate. Even online microbusinesses need access to a computer or device and an internet connection. Other types of businesses may have much more demanding equipment needs that could cost tens or even hundreds of thousands of dollars.

Below is a look at sample startup equipment costs for several different types of industries. (Your experience could be different.)

• Hotels and restaurants: $125,000
• Real estate and rentals: $75,000
• Insurance and finance: $52,000
• Retail establishments: $32,000
• Health care: $27,000
• Warehousing and transportation: $16,000
• Arts and entertainment: $16,000
• Service-based businesses: $14,000–$18,000
• Construction: $14,000
• Support for other businesses (administrative or janitorial): $11,000

Office Space ($300–$1,230 per Month, per Employee)

With certain types of businesses, you might be able to operate from your home. But if your company requires office space, the cost of renting or buying a facility can add up.

Just like residential rent and mortgage costs, the price of securing office space for your business has a lot to do with your location. The size of your office will of course influence the price you pay as well.

The cost of office space starts around $300 per month (per employee). Yet in high-cost areas like San Francisco or New York, your monthly office space cost could be over $1,230 per person.

Utilities ($2.14 Per Square Foot)

On top of a monthly lease or loan payment for office space, you need to prepare for the added expense of utility services. For commercial buildings, the average utility cost is $2.14 per square foot, according to Building Owners and Managers Association International. The larger your office space and the more employees your business has, the higher its utility costs may climb.

Inventory (25%–35% of Operational Budget)

If your company plans to sell products to its customers, you’ll need to have some inventory on hand to fulfill orders. Inventory costs can require a significant financial investment. But the actual amount your business needs to spend here depends on numerous factors.

Most businesses that require inventory spend between 25% to 35% of their operational budgets on related costs. Initially, it can be hard to gauge how much your business will spend in this category. To estimate potential inventory costs, start by figuring out how much product you expect to sell in a 12-month period. Then, divide that number by 10, aiming to keep 10% of your annual inventory needs in stock.

Let’s say you plan to sell $75,000 in inventory over the next year. If you wanted to keep 10% of that number available to sell to customers, you’d need to purchase $7,500 in inventory.

Marketing and Advertising (Up to 7%–8% of Revenue)

Getting the word out about your business is essential. But you have to be careful not to overdo it on marketing and advertising expenses—especially as a new company.

The SBA advises limiting your marketing expenses to 7% or 8% of your revenue. However, if your profit margins are on the low side (less than 10%), you might want to adjust your marketing budget down until those numbers improve.

Website Development (Up to $10,000)

Creating a professional online presence is essential for most businesses. The question you have to answer as a startup is whether you want to hire someone to create a website for your business or try to tackle the project yourself.

Depending on your skill set and time constraints, you might be able to design your own starter website. Services like Squarespace and WordPress have templates available that can make the job easier and far more affordable. If you hire a professional website designer to develop your website, the cost might run between $2,000 and $10,000. However, website packages often include branding services that could benefit your business as well.

Office Supplies and Furniture ($200–$1,000 per Month, per Employee)

Whether you’re operating your business from home or you have a dedicated outside office space, your business will probably need to spend some money on office supplies. Depending on the type of business, you might need to purchase:

• Chairs and desks
• Computers, tablets and software
• Phones and headsets
• Breakroom furniture and appliances
• Waiting room furniture
• Filing cabinets
• Paper goods
• Ink, toner and other printing supplies
• Pens, paperclips, staples and notebooks

You might spend anywhere from $200 to $1,000 per month (per employee) on office supplies. But these costs can vary widely depending on your budgeting choices and the types of perks you want to offer employees.

Payroll (15% to 50% of Your Budget)

Payroll is one of the biggest expenses most businesses encounter. Yet finding quality team members and providing them with fair and competitive compensation is crucial if you want your company to thrive.

For many companies, payroll costs account for anywhere from 15% to 30% of their overall budget. Some businesses dedicate up to half of their budget to payroll expenses and still generate significant profit margins.

On top of salary and wages, be sure to factor the following costs into your company’s payroll expenses:

• Commissions
• Paid time off
• Overtime pay

Professional Consultants ($75 to $400 per Hour)

As a new business, there may be many tasks that you try to manage on your own to save money. The cost of professional services, after all, can be pricey—running anywhere from $75 to $400 per hour.

For certain jobs, however, hiring a professional could be a wise investment. For legal matters , paying an attorney for advice and guidance can help you avoid potentially costly mistakes. Working with a CPA or bookkeeper could help your business make sure it’s meeting its tax obligations as required.

Insurance ($46–$86 per Month, per Policy)

Insurance is another important cost you should budget for as a new business owner. Depending on the type of business you operate, some types of business insurance coverage may be more important than others.

Below are some of the insurance options you may want to consider, along with the median monthly premium for each.

• Workers’ compensation: $86 per month
• General liability: $53 per month
• Business owners’ policy: $84 per month
• Professional liability: $46 per month

If you take out multiple business insurance policies with the same provider, you might be eligible for a bundle discount that could help you save money.

Taxes (Cost Varies)

Benjamin Franklin once wrote that nothing is certain in this world except death and taxes. So, it shouldn’t come as a surprise that your new business will have tax obligations to pay as well.

Your business structure, revenue and expenses can all influence how much your business has to pay in taxes. Working with a CPA to calculate your tax requirements and look for potential savings strategies is often your best bet.

The corporate tax rate is currently 21%, but there have been recent proposals in Congress to increase that number. In general, saving at least 25% of business profits is advisable, but you should talk to a reputable tax professional for advice.

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How to Get Startup Business Financing

Finding the funds to cover startup costs, not to mention other business expenses that may arise, can be a challenge. But the right business financing has the potential to break big expenses down into smaller payments that are easier to manage.

If you’re interested in applying for a business loan, calculate how much you can afford to pay each month so that you don’t overextend yourself. Then, take the time to research and compare available business financing options to make sure you find the best deal available for your company.

Related: Best Startup Business Loans

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Jordan Tarver has spent seven years covering mortgage, personal loan and business loan content for leading financial publications such as Forbes Advisor. He blends knowledge from his bachelor's degree in business finance, his experience as a top performer in the mortgage industry and his entrepreneurial success to simplify complex financial topics. Jordan aims to make mortgages and loans understandable.

Estimating Cost of a Project: Techniques and Examples

Estimating cost is an important process in project management as it is the basis for determining and controlling the project budget. Costs are estimated for the first time at the beginning of a project or even before a project has started. Subsequently, the (re-)estimation of the project cost is repeated on an ongoing basis to account for more detailed information or changes to the scope or timeline.

For instance, if the earned value management measures that are used for controlling project cost indicate significant variances from the budget, a re-estimation of the cost and schedule and a revisiting of the overall budget can be inevitable.

The methods introduced in this article are tools and techniques of the “Estimate Costs” process that is part of PMI’s Knowledge Area “Project Cost Management” (see PMBOK®, 6 th edition, ch. 7.2).

What Is a Cost Estimate?

Rough order of magnitude vs. definitive estimate, estimate to complete (etc) and estimate at completion (eac), when are cost estimated, why is cost estimation important in project management, comparison of estimation techniques, expert judgment       , analogous estimating , parametric estimating, bottom-up estimating, three-point estimating.

A Cost estimate is a quantified expectation of how many resources are required to complete a project or parts of a project.

Such cost estimates are often expressed in currency units. However, other units such as man-days can also be used if the currency amounts are not applicable or irrelevant.

There are different types of cost estimates. The Project Management Body of Knowledge lists the rough order of magnitude (ROM) and the definitive estimate. Both types differ in respect of their accuracy, the project phases in which they are used as well as the available tools and techniques. Some projects use additional, sometimes industry-specific types of estimates.

Cost estimating involves different tools and techniques which typically include

• Expert judgment,
• Analogous estimating,
• Parametric estimating,
• Bottom-up estimating,
• Three-point estimating, and
• Cost of quality.

Read on to learn the details of these techniques, supplemented with examples and practical considerations.

What Are the Types of Cost Estimates?

According to the PMBOK®, there are 2 types of cost estimates:

• Rough order of magnitude (ROM) with an accuracy of -25% to + 75% (other frameworks quote a range of +/-50%) and
• Definitive estimate with an accuracy range of -5% to +10%.

Some sources also list so-called preliminary estimates and budget estimates as further gradations of estimate types. There are also industry-specific types of estimates such as design and bid estimates in construction projects ( source ). However, the current PMI project management framework only refers to the 2 above-mentioned types.

If the budget has to be revisited part way through a project, a so-called estimate to complete (ETC) is determined.

The obvious difference between these 2 types of estimates is the accuracy: the ROM is rather inaccurate with a broad range of possible outcomes. It is therefore typically used in project initiation phases where a ballpark figure is sufficient to get a project started.

The definitive estimate is determined in the course of the project when more information and resources for accurate estimates are available.

Read this article for more details on the ROM and the differences between ROM and definitive estimate .

If partway in a project it turns out that the budget baseline (based on previous estimates) cannot be met, a re-estimation of the project cost is required.

This is done by determining an estimate to complete (ETC) which is used to calculate a new estimate at completion (EAC) that replaces the initial budget at completion and thus becomes the new cost baseline of a project.

Costs are estimated at different points in time throughout the project. The PMBOK states that the process is performed “periodically throughout the project as needed” (source: PMBOK®, 6 th edition, ch. 7.2).

The first point to estimate cost is during the initiation phase, e.g. when the project business case or the project charter is created. For these documents, a project manager has to determine the amount of resources that is required to complete the project.

As the information that is available at that point is usually not very detailed, the project manager will likely end up producing a rough order of magnitude estimate rather than a definitive estimate. Later in the project when more information is available, this order of magnitude estimate will be replaced with a definitive estimate.

After the project initiation phase, the cost will be re-assessed during the planning phase, using the techniques introduced in this article.

In subsequent phases, costs are typically (re-)estimated if relevant new information and details become known or if changes to the project scope or timeline occur. One of the common reasons for re-estimating cost is, for instance, when the indicators of the project controlling suggest that the original budget baseline cannot be met.

Estimating costs is one of the core activities of project management and planning. This is because a project is defined as being subject to at least three fundamental constraints : scope , budget and time. Cost estimates are obviously addressing the budget constraint; hence they are highly relevant for the management of a project. The initial rough cost estimate is usually included in the project charter as well as in the business case of a project.

The estimation of costs is also necessary to compute the project budget which is subject to the approval of the project sponsor(s). In fact, the process “determine budget” uses a technique called “cost aggregation” which directly refers to the outputs of the “estimate cost” process.

Cost estimates are the basis for allocating budget to work packages and deliverables which can be politically sensitive within a project as well as among its stakeholders. Therefore, budget determination and assignment require some stakeholder involvement, communication and, in many cases, their approval.

In addition, cost estimates are input parameters for the earned value and variance analyses as well as forecasting of project costs .

Tools and Techniques for Estimating Project Cost

This section provides an overview of the tools and techniques for estimating project costs. These methods refer to chapter 7.2.2 of PMI’s Project Management Body of Knowledge .

Click on the links to the detailed articles on these techniques to find further explanations and practical examples.

This table compares the approaches to estimating project costs and highlights the differences between these techniques.

This technique is suggested by the PMBOK (ch. 4.1.2.1) as a way to produce a cost estimate.

If you or your team have experience with the kind of work that is in the scope of a project, you can use expert judgment to produce an estimate. This requires a certain level of familiarity with the subject of a project and its environments such as the industry and the organization.

Expert judgment can be applied to both bottom-up and top-down estimating. Its accuracy depends greatly on the number and experience of the experts involved, the clarity of the planned activities and steps as well as the type of the project.

Two examples of expert judgment are:

• Estimating the rough order of magnitude at the beginning of a project. At that time, estimates are often performed top-down due to a lack of team members. more accurate estimation techniques (such as parametric estimating) may also not be available due to a lack of data.
• (Re-)estimating the efforts needed to generate the deliverables of a work breakdown structure (WBS) by asking those responsible for work packages and activities to estimate their resource requirements. This type of expert judgment can lead to comparatively accurate results.

Besides being an estimation technique on its own, expert judgment is also inherent to the other estimation techniques. For instance, if the comparability of previous work and the current project is assessed or adjustments to parametric estimates are determined.

Analogous estimating refers to the use of observed cost figures and related values in previous projects (or portions of a project). In order to be accurate, the type and nature of these reference activities must be comparable with the current project.

“Analogous estimating, also called top-down estimating, is a form of expert judgment.” Source: Heldman, Kim. PMP: Project Management Professional Exam Study

This technique uses historical data in the form of values and parameters to determine the expected resource requirements of a current project. The historic values are adopted for the current work and can be adjusted for differences in scope or complexity. Analogous estimating is categorized as a gross value estimating approach.

In general, analogous estimates are used if a project has access to historical data on similar types of work while the details and resources for more accurate estimates in the current project, such as parametric or bottom-up estimating, are not available.

Parametric estimating is a statistical approach to determine the expected resource requirements. It is based on the assumed or proven relationship of parameters and values. Simple examples are the building cost per square foot in construction projects or the implementation cost per data field in IT projects.

If, for instance, the cost of implementing a new data field in an IT system were $20,000 according to historical data, and a project required 15 new data fields, the total cost of this part of the project would be 15 x $20,000 = $300,000.

The input data can be obtained from previous projects or external data sources such as industry benchmarks or publicly available statistics.

In practice, this technique is employed with a broad variety of sophistication and accuracy. It can be used with a simple ‘rule of three’ calculation but also in conjunction with a complex statistical or algorithmic model that may consider multiple quantitative and qualitative parameters for detailed regression analyses.

In projects that do not use an explicit statistical correlation analysis, some expert judgment is required to assess whether it would be reasonable to apply the historic parameters to the current project. Complexities of projects and activities vary and may therefore require certain adjustments.

For instance, building a highway in a mountainous region likely produces a higher cost per mile than in a flat area. IT development projects in complex IT architectures or systems tend to require more resources than a less complex environment.

Another consideration concerns the expertise and experience of the project team. If a previous project was delivered by highly skilled and experienced resources while the current team is just at the beginning of its learning curve, using unadjusted historic data may understate the estimated cost.

Similar to analogous estimates, adjustments can be made to adapt the parametric estimates to the current project.

Depending on the quality of the input data and its applicability to the current type of work, the parametric estimation technique can produce very accurate figures. However, the higher the accuracy desired the more resources are needed to perform the data gathering and statistical analyses.

Bottom-up estimation refers to a technique that involves estimating the cost at a granular level of work units. The estimates for all components of a project are then aggregated in order to determine the overall project cost estimate.

In practice, these estimates are often performed at the lowest level of the work breakdown structure (WBS), e.g. for work packages or even activities.

While there is no clear rule on who should be performing this estimation, it seems to be a good practice in project management: asking those project team members who are operationally in charge of the respective work packages or activities to estimate there on work.

Thus, this approach to estimating costs often comes with significantly higher accuracy than top-down estimations. However, obtaining and aggregating these granular estimates normally requires some resources and can potentially become a political challenge, especially in large or complex projects.

Three-point estimating is a technique that usually leverages on bottom-up estimates, analogous or expert estimates. The concept requires three different points of estimates: the optimistic (best case), pessimistic (worst case) and the most likely cost estimate.

Based on these 3 points, a weighted average cost estimate is determined that overweighs the “most likely” point. This can be done by assuming a triangular distribution, a PERT or beta distribution.

Read this article for further explanation and examples of this technique.

In this article, we have discussed the techniques of cost estimating as suggested by the PMBOK. Note that the level of detail and granularity of the estimates usually increases throughout the project.

In the initiation phase, the rough order of magnitude (ROM) is often the only type of estimate that can be obtained. Definitive estimates will usually require techniques such as analogous, bottom-up and parametric estimating that may only become available in later stages of a project.

Parametric and bottom-up estimates are usually the techniques that provide the most accurate cost projections. They are commonly used if the budget needs to be revisited and replaced with a new estimate at completion.

When a budget is determined and approved, earned value analysis and variance analysis help project managers control the cost and value generated in a project. You will find more details on the measures and the techniques in this article .

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What is project cost estimation? 5-step process with examples

Estimating the cost of digital products is complex and we are often bad at it. Most estimations create false expectations and lead teams to complicated situations.

In this guide, we’ll explain what cost estimation is, why it’s important, and how you can use cost estimation to make informed decisions about resource allocation, budgeting, and project timelines.

What is cost estimation?

Cost estimation involves understanding how much you need to invest to accomplish something. This works best with activities you can repeat and receive the same result.

Take a house, for example. You’ll need to pay for materials, labor, decorations, an engineer, a designer, and so on. It’s possible to calculate everything up front, which means you can get a precise cost estimation.

But, a digital product is different. We cannot calculate everything upfront, although we can have a high-level idea of what kind of investment we’re considering.

Product managers need to pitch ideas all the time. Some companies will risk making a small investment to evaluate whether to fund the initiative further. Other companies will require a cost estimation before betting on the initiative.

Such an estimate allows product managers to avoid wasting time and resources on an initiative that lacks the potential for long term success. Cost estimating gives product managers a more holistic view of a potential product, which allows for a more accurate estimation of what the product will cost.

How to calculate cost estimation

When I worked for agencies, we used to try to have highly detailed estimates for everything. That almost killed us because it took way too long. To mitigate this, we developed an estimation calculation technique designed to streamline the process.

You can create a model estimation calculator by following these steps:

• Get a diverse team — Select experienced professionals from across different business functions , (e.g., software engineers, product managers, etc.)
• Define ranges — Use a scale like T-shirt size. XS to XL is enough
• Pick a reference project — Consider a project you worked on recently, take different features, and categorize them according to your scale
• Define effort for each size — From the business functions you have (UX, UI, software engineering, etc.) define how many days each of them will need to create an XS, S, M, L, and XL feature
• Define integration efforts — Most projects require a certain level of integration. Do the same exercise as before, except this time for the effort feature integration will require

A simple calculator like this will save you a lot of time.

You may stumble upon some projects that require phases, discovery, delivery, testing, and deployment. Estimating in phases is counterproductive. The calculation should contain the overall effort to do all the required work to complete the feature.

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Now, let’s say you have a new project and a list of features to estimate. How do you start? First, check who’s available and gather a small cross-functional team together.

I like playing an estimation game that takes 1–2 hours. It goes like this:

• The product manager writes the requirements on cards
• The product manager prepares a board with the estimation scale (XS, S, M, L, XL)
• The product manager gets the cross-functional team in the room
• The first member takes the card on the top, reads it out loud, and places it where they find fit. They will say why, but there’s no discussion
• The next team member can either take a new card and do the above or pick a card on the board, move to another place, and share why they chose that
• The game will continue until the team says it’s ok with it

The result is a high-level estimate of the whole feature set you have. You will have ranges from best case to worst case. Once you have this information you can make an informed decision about whether the product is worth pursuing, or if the team should pivot its attention towards something with more potential.

Cost estimation example

Let’s look at a real-world example to show how cost estimation works in practice.

Imagine you’re working on a new project for a healthcare application with features such as appointment booking, secure messaging between patients and healthcare providers, and a medical history tracker.

To estimate the costs for this example project, you can follow the steps outlined above. Your cost estimation process might look something like this:

• Assemble a diverse team of professionals, including software engineers experienced in healthcare data security and privacy, UX/UI designers with knowledge of healthcare user requirements, product managers familiar with healthcare regulations, and a domain expert in the healthcare industry
• XS — Small UI adjustments or bug fixes
• S — Implementing appointment reminders or notifications
• M — Designing and implementing the secure messaging feature
• L — Developing the appointment booking system with a calendar and provider availability.
• XL — Creating the medical history tracker that integrates with electronic health records (EHR) systems
• Choose a reference project with similar features, such as a telemedicine app, and categorize its features according to the T-shirt size scale described above
• Software engineer — XS, 1 day; S, 3 days; M, 7 days; L, 10 days; XL, 15 days
• UX/UI designer — XS, 1 day; S, 2 days; M, 5 days; L, 7 days; XL, 10 days
• Product manager — XS, 0.5 day; S, 1 day; M, 2 days; L, 3 days; XL, 4 days
• Domain expert — XS, 0.5 day; S, 1 day; M, 3 days; L, 4 days; XL, 6 days
• Estimate the integration efforts for each feature size, considering data security and privacy, third-party integrations (such as EHR systems), and compliance with healthcare regulations

Factors affecting cost estimation

The digital product development space can be unpredictable. Many aspects contribute to project delays and flawed estimations that hinder the success of your products.

These miscalculations can cause bottlenecks for your team that throw off the process of the current and future products. Misallocation also can result in having to shift time and resources away from another product to fund the one you are currently working on.

Here are vital aspects to consider when trying to arrive at the most accurate estimation:

• Team experience — How experienced are the team members within the technology you’re about to use? Let’s assume a team of five people where two are inexperienced. You’ll need to have experienced professionals helping inexperienced ones
• Domain knowledge — How’s your domain knowledge? If you lack that, you will need business stakeholders to cover the gap. Their availability is critical to your progress
• Dependencies — How dependent are you on others? You can expect delays if you have dependencies with other teams, service providers, freelancers, businesses, etc.
• End users — How easily can you get in touch with end users? The more complicated, the more delays you face. In B2B, getting closer to end users is generally more complex than in B2C
• Teamwork — How long has the team been working together? With new teams, it takes a while for things to start moving smoothly

Be mindful of your scenario and adapt your estimations accordingly.

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Using cost estimation for decision-making

It’s fundamental to understand that estimates aren’t commitments.

When you estimate something as a month, you’re essentially saying, “Based on what I know now, this looks like a month of work.” But, after two weeks you may realize that you need one and a half months, or maybe just three weeks. Having this understanding is critical to decision-making.

Companies have limited resources. Because of this, they must carefully pick what they will work on next. Cost estimation plays a role in it. Companies want to deliver more value in a short amount of time.

Knowing the cost estimation of something will also help you understand the kind of investment you’re talking about.

Cost estimation is imprecise by nature. You can be more predictable with time, but the beauty of product management is inspecting and adapting. The more you learn, the more you change.

Practice transparency. Use the estimation as a starting point, but don’t let the numbers trap you. As you discover something, share that and adapt your estimates.

Also, remember that it’s important to limit the estimations to a bare minimum. You want to invest your energy into getting the work done instead of discussing how to do it.

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Project Cost Estimation: How to Estimate Project Cost

Good cost estimation is essential for project management success. Many costs can appear over the project management life cycle, and an accurate project cost estimation method can be the difference between a successful plan and a failed one. Project cost estimating, however, is easier said than done. Projects bring risks, and risks bring unexpected costs and cost management issues.

What Is Project Cost Estimation?

Project cost estimation is the process that takes direct costs, indirect costs and other types of project costs into account and calculates a budget that meets the financial commitment necessary for a successful project. To do this, project managers and project estimators use a cost breakdown structure to determine all the costs in a project.

Project cost estimation is critical for any type of project , from building a bridge to developing that new killer app. Everything costs money, so the clearer you are on the amount required, the more likely you and your project team will achieve your objective.

Project cost estimating is a critical step during the project planning phase because it helps project managers create a project budget that covers the project costs that are needed to achieve the goals and objectives of the project set forth by executives and project stakeholders.

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Project Estimate Template

Use this free Project Estimate Template for Excel to manage your projects better.

What Is a Project Estimate?

A project estimate is the process of accurately forecasting the time, cost and resources required for a project. This is done by looking at historical data, getting information from the client and itemizing each resource and its duration of use in the project.

To create a project estimate, you should first define your project scope and then create a project cost breakdown structure, which allows you to pinpoint all of your different project costs for each stage of the project life cycle.

Project cost estimation is simplified with the help of project management software like ProjectManager . Add project budgets and planned costs for specific tasks and include labor rates for your team. When you build your plan on our Gantt chart, your estimated project costs will calculate automatically. Plus, as the project unfolds, you can track your costs in real time on our automated dashboard. Try it for free today.

What Is a Project Cost Breakdown Structure?

A cost breakdown structure (CBS) is a very important project costing tool that details the individual costs of a project on a document. Similar to a work breakdown structure (WBS) , it’s a hierarchical chart where each row represents a type of cost or item. This is done at the task level, which is called a bottom-up analysis.

Creating a cost breakdown structure might be time-consuming, but one that’s worth the effort in that the result is a more accurate estimate of costs than you’d get with a top-down approach, such as basing all your estimates on the costs of previous, similar projects.

Using a cost breakdown structure is an essential part of project cost management and resource management . By zeroing in on costs at the task level early during the project planning phase, you’re less likely to miss hidden costs that could come up later during the project execution stage and throw your project budget off.

Types of Project Costs

There are five main types of costs that make up your total project cost. Here’s a quick overview of these types of project costs and how to measure them.

• Direct costs: Direct costs are those that occur in a project and are attached to specific activities. These are generally costs that are easier to accurately estimate. They include raw materials, labor, supplies, etc.
• Indirect costs: Indirect costs in a project are those that are in support of the project, such as administrative fees. These can include everything from rent to salaries of the administrative staff to utilities, etc.
• Fixed costs: Fixed costs, as the name suggests, are those that don’t change throughout the life cycle of a project . Some examples of fixed costs include setup costs, rental costs, insurance premiums, property taxes, etc.
• Variable costs: Variable costs are costs that change due to the amount of work that’s done in the project and are variable in nature. These costs can include hourly labor wages, materials, fuel costs and so on.
• Sunk costs: In project cost estimating, when an investment has already been incurred and can’t be recovered it’s called a sunk cost or retrospective cost. Some examples of sunk costs include marketing, research, installation of new software, etc.

Free Project Cost Estimation Template

ProjectManager has free templates for every aspect of managing a project, including a free cost estimate template for Excel. It can be used for any project by simply replacing the items in the description column with those items that are relevant to your project.

This free cost estimate template has all the fields you’d need to fill in when estimating project costs. For example, there’s the description column followed by the vendor or subcontractor column and then there are columns to capture the labor and raw materials costs. These can be added together by line and then a total project cost can be calculated by the template.

Naturally, a cost estimate template is a static document. It’s handy in terms of collecting all your project costs and tracking them over the life cycle of the project. However, all that data must be manually added, which takes time and effort—two things that you don’t have in abundance when managing a project. Once you’re ready to streamline the cost estimate process you’ll find that there are many project management software solutions that can build budgets and track them in real time to keep you from overspending.

What Does a Project Estimator Do?

The project estimator or cost estimator, is tasked with figuring out the duration of the project in order to deliver it successfully. This includes determining the resources needed, including labor, materials, etc., which informs the project budget .

In order to do this, a project estimator must understand the project and its phases and be able to research the historical data of projects that were similar and executed in the past. Cost estimators also need to have a firm grasp of mathematical concepts.

Unlike a project manager , who’s responsible for the delivery and oversight of the project, a project estimator is focused on the direct and indirect costs associated with the project. Project estimators work closely with contractual professionals to develop accurate estimates, which are presented to project leaders.

Project Cost Estimation Techniques

All of these factors impact project cost estimation, making it difficult to come up with precise estimates. Luckily, there are cost estimating techniques that can help with developing a more accurate cost estimation.

Analogous Estimating

Seek the help of experts who have experience in similar projects, or use your own historical data. If you have access to relevant historical data, try analogous estimating, which can show precedents that help define what your future costs will be in the early stages of the project.

Parametric Estimating

There’s statistical modeling or parametric estimating , another cost estimation method that also uses historical data of key cost drivers and then calculates what those costs would be if the duration or another of the project is changed.

Bottom-Up Estimating

A more granular approach is bottom-up estimating, which uses estimates of individual tasks and then adds those up to determine the overall cost of the project. This cost-estimating method is even more detailed than parametric estimating and is used in complex projects with many variables such as software development or construction projects .

Three-Point Estimate

Another approach is the three-point estimate, which comes up with three scenarios: most likely, optimistic and pessimistic ranges. These are then put into an equation to develop an estimation.

Reserve Analysis

Reserve analysis determines how much contingency reserve must be allocated. This cost estimation method tries to wrangle uncertainty.

Cost of Quality

Cost of quality uses money spent during the project to avoid failures and money applied after the project to address failures. This can help fine-tune your overall project cost estimation. Plus, comparing bids from vendors can also help figure out costs.

Dynamic Project Costing Tools

Whenever you’re estimating costs, it helps to use online software to collect all of your project information. Project management software can be used in Congress with many of these techniques to help facilitate the process. Use online software to define your project teams, tasks and goals. Even manage your vendors and track costs as the project unfolds. We’ll show you how.

How to Estimate Project Costs in 10 Steps

The U.S. government has identified a 10-step process that results in reliable and valid cost estimates for project management . Those steps are outlined below.

• Define the cost estimate’s purpose: Determine the purpose of the cost estimate, the level of detail that is required, who receives the estimate and the overall scope of the estimate.
• Develop an estimating plan: Assemble a cost-estimating team and outline their estimation techniques. Develop a timeline , and determine who will do the independent cost estimate. Finally, create the team’s schedule.
• Define characteristics: Create a baseline description of the purpose, system and performance characteristics. This includes any technology implications, system configurations, schedules, strategies and relations to existing systems. Don’t forget support, security, risk items, testing and production, deployment and maintenance and any similar legacy systems.
• Determine cost estimating techniques: Define a work breakdown structure (WBS) and choose an estimating method that’s best suited for each element in the WBS. Cross-check for cost and schedule drivers; then create a checklist.
• Identify rules, assumptions and obtain data: Clearly define what’s included and excluded from the estimate and identify specific assumptions.
• Develop a point estimate: Develop a cost model by estimating each WBS element.
• Conduct a sensitivity analysis: Test the sensitivity of costs to changes in estimating input values and key assumptions, and determine key cost drivers.
• Conduct risk and uncertainty analysis: Determine the cost, schedule and technical risks inherent with each item on the WBS and how to manage them.
• Document the estimate and present it to management: Having documentation for each step in the cost estimate process keeps everyone on the same page with the cost estimate. Then you can brief the project stakeholders on cost estimates to get their approval.
• Update the cost estimate: Any changes to the cost estimate must be updated and reported . Also, perform a postmortem where you can document lessons learned.

Project Cost Estimation Example

Let’s take a moment to create a hypothetical project and run through a general cost estimate example to see how this process works. Construction cost estimation is straightforward so we’ll use a construction estimate example. This construction project will focus on the general requirements for cost estimation in project management.

First, you’ll want to have a list describing the various elements needed to build your construction project. Gather all your construction project management documents such as plans, designs and specifications, blueprints and permits to find out cost data. In your documents, you’ll find administrative costs, financing costs, legal fees, engineering fees, insurance and other cost items.

Now it’s time to use a work breakdown structure (WBS) to identify all your construction project activities. Identify the labor costs, direct costs and indirect costs associated with every activity in your project schedule. There are various cost estimating techniques such as bottom-up estimating which allow contractors to estimate costs for each construction activity to create accurate proposals for the construction bidding process.

These costs are then added together for a line total, and those line totals are added together to determine your total project cost. Having a cost estimation template is a good tool to collect and track this information.

ProjectManager Helps With Project Cost Estimation

ProjectManager is a project management software that has features to help create a more accurate project cost estimate. Our Gantt chart can be used to help you track costs and expenditures for projects and tasks.

Estimate Costs of Specific Tasks

When estimating individual tasks, costs can also be collected and tracked on our online Gantt chart. Here you can add a column for the estimated costs, baseline cost and the actual costs to help you keep the project on budget once it’s been executed.

Our online Gantt chart can not only track tasks, but you can set it up to track materials and fixed costs associated with each project task and monitor the difference between budget and actual costs. All of this data is collected on one page.

Start by creating a project and then go to the Gantt view on ProjectManager. If you already have data, you can import it by clicking on the import button on the top right-hand side of the page. Or you can use this online Gantt chart to collect the data. It can be easily shared with team members and stakeholders when you’re ready to get input or approval.

Estimate Costs of Resources

The resource management feature on ProjectManager is another tool that can help you achieve a more accurate project cost estimate. It offers a way to look at your costs through the workload across tasks and projects.

When planning a project with our resource management tool , you can account for employee schedules, equipment rentals, holidays and office space, among other factors that’ll impact your budget. Distributing project resources is one way to balance a budget.

Create a resource plan by scheduling the dates for planned resources, how long you’ll need them and the people who will be involved. That includes any equipment or site rentals. Break that down into the number of resources needed for each activity on a daily basis and you’ll be able to create a schedule with detailed resources, including duration and estimated costs.

FAQs About Project Cost Estimation

Here are some of the most frequently asked questions about project cost estimation online.

What Is Project Cost Analysis?

A project cost analysis is used to determine the costs and benefits associated with a project. It’s a process used to determine if the project is feasible.

What Is a Project Cost Breakdown?

A project cost breakdown is the process by which a project manager estimates what will need to be spent in order to deliver a project. A cost breakdown structure is used during the project cost estimating process to ensure all costs are accounted for.

Why Is Project Cost Estimation Important?

Cost estimation and cost management are an essential part of project management. The project manager is responsible for making the most accurate project budget possible by using a cost breakdown structure and project estimating techniques.

The project budget collects indirect costs and direct costs as it estimates the overall cost of delivering the project on time and meeting quality expectations. That means, whatever you’re going to need to make the project a success will be thought through during the cost estimation process.

Related Content

• Project Estimation Techniques: A Quick Guide
• Time Estimation in Project Management: Tips & Techniques
• Calculating Estimate at Completion (EAC)
• Parametric Estimating In Project Management
• What Is Job Costing? When to Use a Costing Sheet (Example Included)

When estimating costs on a project, you want to have the best tools to help you calculate a more accurate budget. ProjectManager is online project management software with online Gantt charts and resource management features that give you control over your project costs. See how ProjectManager can assist with your project cost estimation by taking this free 30-day trial today.

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What is estimated production cost in business plan?

Production costs refer to the costs a company incurs from manufacturing a product or providing a service that generates revenue for the company. Production costs can include a variety of expenses, such as labor, raw materials, consumable manufacturing supplies, and general overhead.

What is included in the production plan of a business plan?

5 key factors of a production plan

• Forecast market expectations. To plan effectively, you will need to estimate potential sales with some reliability. …
• Inventory control. …
• Availability of equipment and human resources. …
• Standardized steps and time. …
• Risk factors.

What is production summary in business plan?

A production plan serves as a guide for your company’s production activities. It establishes and sequences activities which must be carried out to achieve a production target, so that all staff involved are aware of who needs to do what, when, where and how.

What is the importance of production cost?

Cost of production is a fundamental economic concept that applies to nearly any business model. Due to the high risk and slim profit margins of farm businesses, it is particularly important that producers understand the costs and potential revenue associated with each enterprise they manage.

What are the 4 costs of production?

Types of Costs of Production

• Fixed costs. Fixed costs are expenses that do not change with the amount of output produced. …
• Variable costs. Variable costs are costs that change with the changes in the level of production. …
• Total cost. Total cost encompasses both variable and fixed costs. …
• Average cost. …
• Marginal cost.

What are examples of product costs?

Examples of product costs are direct materials, direct labor, and allocated factory overhead. Examples of period costs are general and administrative expenses, such as rent, office depreciation, office supplies, and utilities.

How do you write a production process plan?

Production Planning in 5 Steps

• Step 1: forecast the demand of your product.
• Step 2: determine potential options for production.
• Step 3: choose the option for production that use the combination of resources more effectively.
• Step 4: monitor and control.
• Step 5: Adjust.

What is an example of a production process?

An airplane, for example, is created by assembling thousands of parts, which are its raw material inputs. Steel manufacturers use heat to transform iron and other materials into steel. In services, customers may play a role in the transformation process.

How do you write a sales and production plan?

Create a sales plan

• define a set of sales targets for your business.
• choose sales approaches that are suited to your target market.
• identify sales tactics for your sales team.
• activate, motivate and focus your sales team.
• budget and clarify steps you’ll take to achieve your targets.

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