Accounting & Creating a Business Plan for Startup Costs
Few things are as exciting as planning and preparing for a new business. A solid, carefully researched plan will go far to help ensure the success of your startup. While projections and proformas are an important part of any business plan, the accurate estimation of startup costs is vital in securing financing and succeeding in the early stages of the business. How those startup costs are accounted for will also matter later. Here we’ll look at creating a business plan for startup costs and the associated accounting.
Defining Startup Costs
While it may seem self-evident, exactly what constitutes a startup cost is not so cut-and-dry. As a prospective business owner, you would likely define startup costs as everything needed to get the business up and running, from physical plant and equipment to inventory and working capital. That is a perfectly logical and serviceable definition, and in your business plan it is appropriate to label your estimates of these costs in this manner. A simple way to think of startup costs is of all the costs that will be incurred before revenue begins flowing.
However, from an accounting and tax standpoint, startup costs are defined differently: they are the expenses incurred before operations begin. This may seem no different from the definition above, but keep in mind that things like real estate, leasehold improvements, furniture, equipment, vehicles, and inventory are not expenses from an accounting standpoint—they are assets. That means they do not impact the income statement. Instead, these appear only on the balance sheet, where they are simply traded for another asset (if purchased with cash) or balanced against a liability (if purchased with loan proceeds). We’ll look more closely at this in a moment.
Estimating and Planning for Startup Costs
Generally, the fixed (and in some cases intangible) asset portion of your startup costs will be the easiest to predict. The costs of a storefront, office, vehicles, equipment, and so forth can be determined in advance, as can such intangibles as franchise or license fees, if applicable.
Determining what will be required for working capital is more challenging, because while expenses can be estimated fairly accurately, this figure depends mostly on the speed with which sales ramp up. Remember that if you sell on credit, you must factor the time required for customers to pay their invoices into your cash flow needs. Also, if your business relies on inventory, keep in mind that you must account for inventory replacement at a rate proportionate to sales.
Accounting for Startup Costs
Previously, we mentioned that startup costs are defined differently from an accounting standpoint. There are two standards: generally-accepted accounting principles (GAAP) and tax. While GAAP is a concern mostly for public companies, which are required by SEC regulations to use it, GAAP usually is an issue for small businesses only if required by loan covenants.
Under GAAP, all expenses incurred prior to the commencement of operations (such as wages paid while training staff, utility bills, and rent) are classified together as startup costs, which is an “other expense” account. This means that it is segregated from the costs of ongoing regular operations. Under IRS rules, startup costs can be capitalized, which from an accounting standpoint means they are placed on the balance sheet as an asset, and amortized. However, this is permitted only for the first operating location owned by a given legal entity—the first restaurant or retail store, for example. Startup costs for all following locations must be expensed.
Get Help Accounting and Planning for Startup Costs
Accurately estimating the startup costs for a new business is far more complicated than we can explain in a few paragraphs. Just as you should have an attorney review your lease, loan documents, or credit agreement, you should have professional assistance in determining what it will take to get your new business up and running. BroadCreek financial professionals are available to lend our expertise to every phase of your business, from startup to exit planning.
Contact us today to find out how we can take your startup planning from a guessing game to expert predictions.