Understanding cost structures

The accuracy of your assumptions on revenues and costs will determine the business case for your startup. Hence, it is critical that all cost elements are identified, and the accompanying costs are estimated and accounted for.

In the initial phase of the startup, it is important for the entrepreneur to create an excel sheet with all possible cost categories. This should be done on a month-to-month basis to get a better view on the month-by-month cash flow needs.

Costs should be marked broadly into the following categories:

  1. Capital costs [e.g. computers, servers, furniture, etc.[
  2. Operating expenses or opex
    1. Fixed opex [e.g. rent, salaries, etc.]
    2. Variable opex [printing, marketing, travel, etc]

 

Suggestions:

  • Before starting to estimate costs, invest time in developing a good excel sheet with all possible cost heads identified. Instead of using absolute numbers, put formulae so that one change in the base figure can reflect accurately across the entire plan.
  • Break costs into as granular level as possible. E.g. while estimating capital costs, under ‘Servers’ instead of putting a number for that month, break it into “number of servers’ in one row and ‘cost per server’ into another row, with the result of that calculation into the third row. This way, you can make adjustments to the cost per unit or the number of unit without having to worry about making the change everywhere.

 

Once you start writing down the different cost heads under these three categories, often you will realize that there are many more cost heads than you had thought without putting them down in an excel sheet. Once you start putting things down on an excel sheet, you are able to get a good view of how things are going to progress. E.g. in the excel sheet once you realize that the number of people is increasing, you may realize that the office space may be inadequate and hence you may need to budget for not just new & bigger office rent but also for capital costs like brokerage, furniture, etc.

One of the highest cost units is likely to be salaries. While estimating salaries, it is important to account for hiring costs [usually I month salary or 8.33%]. If the attrition rate in your industry is high, you should account for more hiring costs.

Most entrepreneurs go wrong in estimating their people needs, and assuming that they would be able to manage the business with lesser people than practically required.

While estimating people needs, rather than putting down an amount, put down first all the designations on which you are likely to need people at the growth stage. Then  in the column section, put the number of people you would need in each designation and at what stage. E.g. while you may have identified ‘Chief Procurement Officer or CPO’ as a designation for an e-comemrce company you may not have plans for such a person for the first 18 months, in which case enter ‘0’ in the number of people column against the CPO.

In a row below each designation, enter the per month CTC or gross salary. And below that row would be the result of multiplying the number of people for that designation by the monthly salary for that person. See example below:

  January February March April
Customer support manager 1 1 1 2
CTC pm 25000 25000 25000 25000
Total 25000 25000 25000 50000

 

 

Important: In the initial phase you will be resource starved and will therefore manage with very few people than ideally needed. Even if you are able to multi-task and manage the operations with very few people, it is often not scalable beyond a point. Any case, the business case is to be made with the full cost structures as they would apply when the business is at scale.

To explain this further… your business plan should take into account all possible cost structures, even if you are not currently spending them. E.g. you may be working out of your home, or in some cases not even taking a salary. But operating without a salary or operating without an office is not really a long-term option. Hence, for getting a realistic picture of your business case and profitability, it is important to account for all possible cost structures.

Separately, when you work out your operating plan for the first phase you will eliminate or reduce the expenses as they would be actually applicable.

 

In some businesses the cost of unsold inventory, damaged goods, etc. also need to be accounted for as they can significantly impact the business case.

 

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Author: Prajakt Raut

Prajakt Raut is the founder of Applyifi.com, and author of the book for startups - ‘Starting Up & Fund Raising’ Prajakt personal goal in life is to encourage and assist a 100,000 people to become entrepreneurs. _____________ Prajakt is the founder of Applyifi - an online platform that provides startups a 36-point scorecard and assessment report on the venture's investment readiness [www.applyifi.com], and helps them improve their odds of getting funded. Prajakt is also the founding partner of The Growth Labs, a platform where growth-stage companies get sharp, incisive advice from senior professionals and experienced entrepreneurs. [www.thegrowthlabs.in] Before starting Applyifi, Prajakt was the head of operations at IAN, founding member of a leading incubator, and the Asia-Director for TiE (2004 - 2007). Previously Prajakt had co-founded Orange Cross, a healthcare services company, and was part of the founding team member of Idealake Technologies. While in college Prajakt had founded a printing business and has spent over 10 years working in leading advertising agencies. Prajakt’s book, ‘Starting Up & Fund Raising’, helps startups understand an investor’s perspective, and helps them improve their odds of getting funded. The book also helps entrepreneurs understand the building blocks of a business.

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