ENTREPRENEURSHIP / SEP. 06, 2014
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How to Run a Cost Analysis for Your Business as You Start It Up

You have a lot on your plate as you start and grow a business. Too much. There are so many issues, and obstacles, and problems, but you’re (hopefully) flying high on cloud 9 with excitement and ambition at the same time. It’s the only way everything will get done.

An often overlooked and relatively easy task to complete early on (on ongoing during the initial stages) is a cost analysis. An informal technique, it can give a quick and dirty snapshot of your business’s financial health. There are definitely more complex and specific methods (get yourself a certified accountant as soon as you can afford one!), but it does work for giving you a ballpark, rough idea.

A cost analysis differs from a cost-benefit analysis (CBA) in some very important ways. Although similar and related, a CBA looks specifically at the pros and cons (or strengths and weaknesses) of any potential business move or decision. It’s used to gauge the ultimate positive or negative effect, typically in monetary terms (will a decision ultimately cost more money than it makes?). A cost analysis, on the other, simply examines how much something will end up costing, all things considered. It usually does not consider the benefits, just the associated costs and fees. Using that, you can decide if something is worthwhile.

Step 1: Identify the Costs. ALL of them

This is more complicated than might initially appear. The first step in a cost analysis is to identify all costs associated with your business. Some will be obvious (rent, office equipment, employee salaries, if any), while others might slip your mind at first (like monthly, bi-monthly, or annual fees for services, subscriptions, or memberships, taxes, utilities, or insurance). Make a list. Brainstorm as many costs as possible. Think about everything. Then, take a break. Put the list aside for at least a day or two. If you’re just starting out, you’ll have plenty of other activities and jobs that need to be done.

Come back to the list later. Read through it slowly. Chances are, new costs that you missed will pop into your head. Add them. Then put the list aside for a few days again, and repeat the whole process. Do this at least 2-3 times to get as accurate a list as possible.

Step 2: Break Up Your Master List into Smaller Groups

After a few rounds of brainstorming, break your long list into at least two sub-groups, FIXED and VARIABLE costs being the most common. A fixed cost is something you either pay once (purchase price for your work laptop, for example), or a repeating cost that does not vary (such as rent). A variable cost can vary from month to month, like utilities (heating costs go up in winter) or supplies (either business or production).

If you’d rather use different sub-groups, that’s fine, too. Just divide your long and unwieldy list into smaller, more manageable chunks.

Step 3: Assign a Value to Each Cost

The unit may vary, but you’re usually going to be working in terms of money (dollars, pounds, euros...whatever). You could actually conduct a cost analysis in terms of hours or something else, but for the sake of simplicity, dollars will be our unit here.

For each item on your carefully divided list, assign a dollar value. Fixed items are easy to input, whereas variable are more difficult. You could either use an average, or even better, copy your list of costs 12 times and make one for each month of the year. If you’re unsure how much utilities will cost this winter, for example, just wait and input those figures when you have them. Your cost analysis will be much more accurate and therefore useful if you complete it slowly. Don’t feel like you need to finish it right away. The faster you do it, the more of a general picture it will provide. Not necessarily a bad thing (you might simply want a fast but imprecise calculation), but worth remembering.

Be realistic and honest at this stage. Assuming you’ll get a bulk discount or find a cheaper location before you actually do is obviously misleading and will skew your analysis. Add everything up to get a basic dollar amount. Record everything in a spreadsheet for easy calculations and changes...you can find free cost analysis (and CBA) spreadsheet templates online with minimal effort.

Once done, take another break. Let the stats and figures percolate in your head for a while.

Step 4: Slash and Burn. Find the Savings

Now that you have a neat list of divided and realistic costs - and a general dollar figure of how much your business costs each month or year - it’s time to look for areas you could save and lower costs. We are NOT talking about cutting corners (scrimp on quality of production costs, for example, and your business is doomed). Is there anything you could remove completely (like that gourmet coffee delivered every morning) without sacrificing quality or safety? If so, cut it. Is there anything you could find for cheaper (like switching to the generic brand at the grocery or drugstore)? If so, do it. Could you negotiate a better deal with your landlord, your delivery service, your suppliers? If so, make it happen. You’ll never know if you don’t investigate.

Consider anything and everything to lower costs. Downgrade your internet (do you really need the fastest tier) and memberships, both professional and personal.

Input the new figures and add it up. Hopefully, you should see a good difference between this new total and the initial one. Then, take another break. Adjust amounts as needed. Continue to look for new savings in every aspect of your business. Sit down with your updated list again in a few weeks, and consider the whole thing. At this stage, you can compare your total cost amount to your estimated income (although stopping short of a true cost-benefit analysis). Are the numbers close? Are you making money, or losing money? Are you moving in the right direction? This is just a rough estimate, after all, but if the numbers don’t work - if they are too far apart - you may need to rethink your business plan and model.  

Other Useful Links

Cost-Benefit Analysis (Wikipedia)

Cost-Benefit Analysis (Mind Tools)

A cost analysis should be done as slowly as possible, taking frequent breaks to gather more intel and let things bounce around in your brain. It’s informal and imperfect, but worth the effort to see, even if only in very loose and easy terms, what your finances look like at this stage. Losing money is okay provided it’s not too much and you can reasonably see that relationship flipping in the not-too-distant future. If not, you could be in trouble. Better to know now than to be “surprised” down the road.

 

Image: istock

 

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