Q. Dear Zenagos,
What’s the best way to calculate how much cash I need for my start-up idea? At this point, I just have my idea and a sense for how much it will cost to manufacture it. I’m not sure about marketing or any other costs?
The best way to calculate how much cash you need for your venture is to build a financial forecast (or “pro forma”). It will take time and energy, but by learning how to build your forecast, you will learn a tremendous amount about how your business works in a very short period of time. It is the most important thing an entrepreneur can do to prepare to launch a business; however, Forbes reports that more than a third of entrepreneurs don’t have a plan for their financial health (Derousseau, 2017). If you don’t know how to make a financial plan, take a program like Zenagos’ Innovation Trek bootcamp for entrepreneurs or get a free mentor from SCORE. You will get there more quickly with support from a true business expert.
What if I just want a ballpark?
If you’re just trying to vet your idea quickly, you can use benchmarks to create a quick-and-dirty (or “back-of-the-envelope”) estimate. Marketing costs vary dramatically from one industry to another and from one business to another, so it’s wise to make a few scenarios: best case, most likely, and worst case. This will let you see the range of possibilities. Here are some cost categories to consider:
Direct Costs or Cost of Goods Sold (“COGS”)
It sounds like you have already put some thought into what it will cost you to manufacture your product. Businesspeople add up all of the costs of creating a product, including raw materials and labor, and call that Cost of Goods Sold (or “COGS”). It is good to keep these costs separate from other costs because doing so will enable you to figure out quickly how many units you need to sell in order to break even (your Break-Even Quantity or “BEQ”). The rest of your costs are often referred to as “overhead” or “fixed costs.”
Employees are typically the largest cost for a business. Don’t forget to “load” the wages to account for employment taxes, employee benefits, and employee-related expenses like workman’s comp insurance. To do this quickly, you can just add a percentage to the estimated wages. The U.S. Bureau of Labor Statistics reports, “[E]mployer compensation costs for civilian workers averaged $41.86 per hour.” Of this, wages/salaries cost $28.88, and benefits cost $12.98 (BLS, 2022). This means that benefits added another 45% to the cost of salaries, which a businessperson might state as “salaries are loaded 45%.” This would mean that you would take your estimate for full-time and part-time wages (those for employees who receive benefits) and multiply it by 1.45. The entrepreneurs we work with run smaller businesses, so they typically estimate 20-25% for their benefits loading. (They multiply salaries by 1.20 to 1.25.) Once you begin operating your business, you will see your actual benefits costs, and your forecasts will be more accurate.
If your business requires physical locations, either for manufacturing or offices/retail or both, then you need to estimate the annual cost. This is typically rent, but it can also be mortgage payments. Rent is often one of the largest costs for a small business, and it is one of the highest risks because it is difficult to offload if business does not go well.
Everyone knows that marketing is important to success in business. Coca Cola spent more than $4 billion on advertising in 2020, which was more than 10% of the entire year’s revenue (Ridder, 2022). However, small businesses generally can’t afford to spend 10% of their revenue on marketing. Web Strategies estimates that businesses overall spend an average of 7.9% of their revenue on marketing. However, Small Business Trends estimates that small businesses spend only 1% of their revenue on marketing. This is because they do the bulk of their marketing through networking and other personal relationship-building. The U.S. Small Business Administration recommends recommends 7% to 8% of revenue as a marketing expense but also suggests that you contact your industry trade association or read industry trade publications to get more precise marketing benchmarks for your industry segment (Lesonsky, 2019).
“Marketing” is just the cost of acquiring the contact information of people who may be interested in your product (called ”leads”). Once you have the leads, someone needs to work those leads, answering their questions, addressing objections, and helping them to move toward purchase. This process (called “sales”) must be accounted for separately. Who will answer the phone and talk to the prospective customers? If you sell your products online, your website may be your salesperson. If that’s the case, make sure you do the research to estimate your website costs. Ecommerce websites are more expensive to build and maintain than display websites. You may be working with an ecommerce partner like Amazon, eBay, or Etsy. If that’s the case, make sure you understand their fee structure.
Fees for attorneys, accountants, bookkeepers, and consultants can add up. Don’t forget to include them in your forecast.
It’s easy to forget that credit card servicers and payment apps take a percentage of every transaction. This can average 3% of revenue, so be sure to include that in your estimate.
In most businesses, you need to account for a percentage of customers who don’t pay on time, or never pay at all. The entrepreneurs we work with at Zenagos typically have to write off 1-3% of their revenue as bad debt. If you have a hard time sending out invoices or pursuing unpaid accounts, it can be more like 5-6%.
If you take out loans to finance your business, be sure to include your loan payments in your expenses. This shouldn’t be too large a burden on the business, but it can be a factor.
Adding up all these costs may be a little overwhelming at first, but it’s a lot better than jumping into business without a plan and then getting stuck. You are wise to be thinking ahead. You won’t be able to anticipate every future scenario, but if you make a practice of thinking ahead, you will be able to compare your performance to your forecast, which increases the probability that you will observe and learn. Entrepreneurship is the process of continuous improvement. Small steps add up!
Derousseau, R. (2017, September 11). More than a third of entrepreneurs are making this big financial mistake. Fortune. Retrieved on December 7, 2022, from https://fortune.com/2017/09/11/retirement-entrepreneur-plan/
Lesonsky, R. (2019, July 9). How to get the most from your marketing budget. Retrieved on July 13, 2022 from https://www.sba.gov/blog/how-get-most-your-marketing-budget
Ridder, M. (2022, March 7). Coca-Cola Company’s advertising expense from 2014 to 2021. Retrieved on July 13, 2022 from https://www.statista.com/statistics/286526/coca-cola-advertising-spending-worldwide/
U.S. Bureau of Labor Statistics. (2022, December 15). Employer costs for employee compensation summary [Press release]. Retrieved on February 9, 2023, from https://www.bls.gov/news.release/ecec.nr0.htm