If you are starting a business, chances are the first thing you thought of was how your business is going to make money. Revenues are the backbone of your business, and your business needs to generate cash flow in order to survive. This is all undoubtedly important, and you are on the right track to formulating your financial model and plan. But inevitably, you are going to have to start carefully planning the costs for your business as well.
Expenses are often one of the most overlooked and underestimated items in starting a company. In fact, 96% of business startups fail within the first ten years because they fail to accurately anticipate their costs and can’t pay their bills any longer. Costs can be unpredictable no matter how certain you are that you have outlined them all, so it is absolutely critical to your business’s financial success that you understand every possible cost that might be relevant to you. Without going into too much detail regarding expense and accounting categories, we want to look at two types of costs: Fixed Costs andVariable Costs. These can be applicable to nearly any size business, so it is highly important to analyze the specific costs that are associated with your own.
Fixed Costs
Fixed costs are costs that are independent of your business’s sales or production output. It doesn’t matter if your startup brings in $1 or $1 million that first year – no matter what amount of revenue you are making, fixed expenses will be the same and have to be paid.
Some examples of Fixed Costs include:
- Rent
- Insurance
- Loan payments
- Equipment Leases
- Subscription Fees
- Licenses/Permits
- Accounting & Legal Fees
- Advertising
- Management Salaries
- Employee Benefits
Careful projection of your fixed costs is vital to the survivability of your business. If revenues suddenly drop or come in lower than expected during a specific period, fixed costs can wipe out your business in the blink of an eye.
When starting a business, one-time fixed costs also need to be kept in mind. For instance, you might need to purchase computers, office equipment, or furniture for that brand new, shiny office space of yours. It is all too common for new companies to treat these as an afterthought.
It is important to note that just because fixed costs do not change with production, does not also mean they won’t change over time. Fixed costs do (and will) change from period to period, depending on your business’s growth and needs.
Variable Costs
I am sure you have already guessed it, but Variable Costs are costs that are dependent on production or sales volume. We will not go too in depth on proper accounting practices, but variable costs typically appear under your Costs of Goods Sold – or the costs that can be directly associated with how your revenues are generated.
Some examples of Variable Costs include:
- Raw Production Materials
- Inventory
- Packaging & Shipping
- Utilities
- Hourly Wages
- Sales Commissions
Unlike fixed costs, all of these variable expenses would be directly dependent on your business’s output. Variable expenses also differ greatly among businesses with different revenue models. For example, a clothing retailer might have a relatively high quantity of variable costs, since most costs would correlate with the amount of clothing being sold. Alternatively, a computer software as a service business could have lower variable costs as they are not selling a tangible good and it is cheaper to add additional customers.
See our post: “Creating a Growth Hypothesis” for more on revenue models
In reality, estimating variable costs can be difficult without knowing your exact levels of production – this can be especially so for startups. But the more you understand and define your potential variable expenses in your budget, the more likely your business will be financially prepared and prosperous.
Related: Projecting start-up costs for a new business
Cost Dependencies
Now you have a good idea of the different types of basic costs your business will incur. Chances are there is more to your expense forecast than just your fixed and variable costs. What if your sales team receives a higher bonus or commission when they reach a specified quota for each month? What happens when you need to upgrade your computer server capacity after reaching a certain amount of customers that have upgraded from a free trial period?
Your business is made up expenses that are contingent on all sorts of different variables, and you need a platform that is going to be capable of incorporating them into your expense model. Your business needs a financial model detailing every possible expense imaginable to your company, including how those expenses fluctuate depending on changes to other variables in your business.
At Hivemetric, we understand that a simple spreadsheet is not going to get you very far in accurately portraying your business’s cost dependencies. With Hivemetric’s flexible expense platform, you can connect your expenses alongside of future revenue generation, product roadmaps, and new marketing campaigns. We keep things simple by giving you predefined expense categories, but we allow you the customization your business needs when outlining its costs. We want your cash flow forecast to be able to tell the full story of how your business operates.