Estimating Start-Up Costs
A brand new business owner seeks input on projecting first-year expenses. January 6, 2005
Question
I'm trying to figure out how much capital I need to start up. Does anyone have a way of figuring out how much they will lose the first year? (Percentage of workflow?) And if so, is this a good idea to show loan officers or not? This is the main reason I need capital - to prepare for slow times the first year and to get the name out there. I want to be honest with the bank, but I don't know if it's alright to tell them I don't expect to turn a profit until the one year mark.
Forum Responses
(Business Forum)
From contributor S:
You should be able to figure out setup cost by adding together the stuff you want and figuring out what you intend to spend on overhead.
As for how much you will loose, I'll say more than some, less than others. Or maybe none.
Start up capital is very important (I should know - I never had any), so try and keep your overhead low. And invest in advertising today. Go to the yellow pages first - you will not be sorry - and ask about the small yellow pages that is distributed in your local area. This can be as little as 60 a month and it will bring in clients. Get advertising logos on your truck or car with your number on it. (If you're not doing business yet, leave a message that tells people when you will be open for business).
Have you seen the real-estate signs on the side of the road? Get ones made with your info and place them at intersections near where your shop is going to be or is. Advertise in local papers, flyers and even penny savers. Get word out there now and you might make a profit this year.
Welcome to the wonderful world of trade. You get a year supply of aspirin free when you apply for a federal tax ID. You will need it.
From contributor T:
Figure out your total expenses for the year - rent, lights, insurance, wages, and so on. That is the start. Figuring how much business you are going to bring in is much tougher. I would do three projects. Small, med, and large in simple terms. By combining them with your cost estimates, you ought to start seeing some trends of how much cash you will need with each scenario. Unfortunately, there is no exact science. Obviously, the more cash the better.
As far as the bank goes, by all means share with them all of your numbers. By showing the bad, better, and good scenarios, it shows that you have done your research and have a realistic approach to business. The most important things a bank looks at for business loans are: Credit of the owner or owners, collateral offered (unsecured is very hard, especially the higher amount you go) and cash flow (based on the numbers you provide). Banks tend to use the bad and better numbers. And if this is a start up, which I assume it is, cash flow also means income from other sources (wife).
From contributor J:
I didn't have any money to lose when I started. So I didn't buy things I couldn't pay cash for, and priced my work so I would make good money. That's how I would go about it.
From contributor T:
Amen. I did the same thing. I did not and still do not have the fanciest of tools, but I put out a good product, and everything is paid for including the building. It makes the lean months a little easier. I understand the need to borrow a little to get started, but I have seen too many shops borrow their way to bankruptcy. I have a good friend and mentor that was a five man high-end shop. He had all of the best and coolest equipment. He just built a new building with all of the bells and whistles. Unfortunately, business is slow and it is killing him. The payments on the machines and building continue.
From contributor P:
It sounds as if you do have a shop set up already. If so, I would think about a line of credit. It may be easier to get, and give you the freedom of borrowing when you need it only. I was told to have enough for my overhead and my pay for 6 months. I can tell you that if you do good work, you are in the right area after your first job. Your name will be in at least 5 other peoples' hands. The nice thing about getting jobs from past work is that they know how your work is, they know your price and also how your company runs. The yellow pages are good, but be careful on how much you sink into them. Make yourself known to designers and then find the good ones you want to work with. If you make the designer look good, they will throw work at you.
From the original questioner:
Thanks for your input. I'm inheriting all the equipment from my current job, as well as the client base. I've worked there for almost 8 years, and we've turned out top-notch work on low budget machines. But it's not machinery updates that I'm looking for (okay, maybe something here or there), but to pay myself a guaranteed amount monthly to support my family. I'm in good with the area's very top designers, but the shop is to be relocated about 25 miles away from its current location. I'm less worried about getting the work than getting the money to make sure I'm taken care of each month. Is $35k a lot to ask a bank for a startup? Has anyone else taken a loan close to this amount? Is it hard to prove its worthiness to a bank? My personal credit has been flawless for 3 years, but not so good before that (I'm only 24 and didn't understand credit until I had a kid). I am positive I can be successful, but only with the money to float me for a year. I'm freakin' out here!
From contributor C:
Not to burst your bubble, but it sounds like you may be premature in starting your own business. There are many unforeseen expenses ahead, even if you have some machinery. A guaranteed monthly income is why people work for others. Not sure about the logic of taking a loan for that. Loans are for things that either appreciate or make you more money than they cost you. Loans will dig you a trench if used unwisely. Most banks will require quite a bit of collateral for this type of loan, which might just be a blessing in disguise. Ramping up your operation over a few years while holding down a day job might be worth consideration.
From the original questioner:
Thanks for your honest advice. I know it's premature for me to start a business, but the way I see it, I've got no choice. The job market is tough, and my research indicates that I can't get paid anywhere near what I was making before. And I have done a lot of reading and planning and learning. I can't take a pay cut and just put these beautiful heavy duty machines in storage (that would cost money, too). The way I see it, now's the time to give it a try, and if it doesn't work down the road, then I'll sell the machines and work for the Home Depot's kitchen design team.
From contributor T:
Thanks for more details. Is 35k a lot to ask for? No, but it needs to be based on something other than a number in the sky. Like contributor P said, 6 months of expenses would be a good start. You actually have an advantage over most for going to a bank. You have 8 years of tax returns and production history to give the banker to show cash flow. They will base it on history and not on future events. 3 years of good credit is not perfect, but it is better than a lot. Most banks look real heavy at the past two years. Again, unsecured lines are the toughest to get. If you can put up something for collateral, then it is a lot easier job. Be professional and make an appointment with the banker. Have all of your past tax returns and personal/business information with you, business plan if you have one, etc. I commend you on thinking ahead instead of - like most people - only thinking about it after you need it.
Side note: When you get your line of credit, please use it correctly. Only use it when you absolutely need it and not for the cool new tool or for a family vacation. Also, use it and pay it back as quickly as you can so it is available to you again. Too many shop owners use it and slowly pay it back and then it becomes maxed out and unavailable when it is needed most.
From contributor J:
I don't know if I misunderstood your reply about "to pay myself a guaranteed amount monthly to support my...", but the contract I have with the bank for my corporate line of credit does not allow me to use it to pay myself.
From the original questioner:
The loan I am seeking is not just so I can get paid, but so all my overhead can get paid too. It doesn't mean I'm looking for a loan to cover my salary, but my salary is part of my shop rate, and when things are slow, I want to be prepared to pay all remaining overhead (salary included).
I'm currently working on my website, portfolio, business plan, financing, and marketing strategies. Is there anything else I should pay attention to?
Contributor J, I think you might have the type of credit I'm looking for. If I can cover every single part of overhead, money taken in can cover what I need to make per month. What steps did you take in getting the line of credit?
From contributor T:
Most of the time, banks can not dictate to you specifically how you use the line of credit. Most of the time... sometimes there are covenants (rules) covering the usage, but it usually is for the big boys with big lines. Salary is overhead and in my thoughts would be acceptable usage.
The steps needed to get a line of credit are as follows. Gather all of your information - business plan, financial statement, projections for the business, tax returns from the business for the past three years. (Very important to get these - they show what the business has done and then you can show what it can do. Banks base loans more on history than future.) Also a list of all of your personal and business information, i.e. addresses, ssn, tin, birthdate - all the stuff that would go on an application. After you have all of this stuff, make an appointment with a local business lender. I would suggest going to a small community bank or the bank that the previous owner did business with. At the appointment, tell the lender what you are looking for. Don't spend a long time telling him all of the grand plans for the future - just a brief overview of the past, present and future and the purpose of the line of credit. Give him your information and wait.
From contributor D:
Your best shot might be to go the SBA and get some help creating some pro forma financial statements before you go to the bank. These days, a computer will most likely decide whether you get the loan or not, not your friendly local banker. To increase your odds, you should prepare a 1-3 year income statement, 1-2 year cash flow statement with a break even analysis estimating fixed costs (overhead), variable costs (cost of goods sold), as well as estimated revenues. You shou\ld be able to back these numbers up. See if you can get some of the regular clients (designers/builders) to express in writing (non-binding) their commitment to working with you and take these to the bank. The break even analysis will also help you determine how much startup cash you need. Be honest with yourself regarding these numbers. If you are the sole source of income for your family, do not let hubris or optimism cloud your judgment regarding what is the best course of action for them.
Plan for success, work your butt off, sell, sell, sell, but have a contingency plan if things don't go as planned. Realize that the factors that contributed to making this business a success for the last 8 years can rapidly change overnight with a new owner (you). Unless you were a part owner/partner of this business, the bank will not give the past financials much weight. They will be investing in you, not the business. You will personally be signing your name on the dotted line, and expect to put some collateral on the line. Don't expect the bank to look at your equipment as collateral. Your house will be the first suggestion.
I know you feel like you have to do this, but take a step back and think clearly. This is a tough business that is seeing increased competition and lower and lower price points that are squeezing out the little guys. Listen to anyone who will give you advice, but you must decide this for yourself.
From the original questioner:
It's so nice to get so many different opinions and ideas. The most important rules that I've learned are to be as well prepared as I possibly can, and to run the woodshop as a true business and not just a hobby. I saw two friends have their business collapse because of these very simple ideas. Being in the current situation, I might have started down that path if it weren't for learning from those two guys, and all on WOODWEB. Who knows what the future holds... but I'm giving it a shot.
