It's a saying older than our grandparents. And as an entrepreneur, you've likely heard it over and over and over again. But is it really true that it takes money to make money?
In a word: Yes. I believe it does take some money to launch any business venture.
Most of the time, though, the upfront costs of starting a business aren't as high as entrepreneurs would expect. And even more frequently, first time business owners without a clear budget in hand spend a lot more money starting their business than is necessary, and more than they'll ever get back.
Ultimately, the cost of making a buck depends heavily on a number of factors. But there are several ways you can predict expenses and keep operational costs from spiraling out of control.
Evaluate Typical Industry Costs
First and foremost, the costs associated with launching your business will be heavily dependent on your industry. Are you manufacturing a product, or providing a service? Does your company operate mostly online, or do you need a brick and mortar storefront? How dependent will you be on hired labor? What kind of equipment will you need to purchase? In general, the more physical resources are required to produce your offering, the more startup costs you will incur.
The most costly expenses starting entrepreneurs typically incur include lease payments on retail, manufacturing, or office space; purchase of equipment or machinery; human resources (hiring employees); and marketing. But how much you spend in each category will vary widely depending on the product or service your business will provide.
Remember Time is Money
Service-based businesses certainly involve fewer upfront costs than those that require manufacturing or purchasing inventory. But even without specific production or startup costs, the time you invest in building your business represents dollars you could be earning doing something else. After all, your time is a precious resource. In fact, it is one of the most finite resources out there.
And remember, even if you're not cutting yourself a paycheck, you still have to eat three meals a day, pay for housing, utilities, clothing, and many other expenses. The time you spend working for free as you build your business represents opportunity cost. So while dollars might not be physically leaving your bank account, building your business is still costing you money in some form.
Don't Forget About Hidden Business Expenses
Beyond the obvious sweat equity and production costs, there are a variety of expenses associated with owning a business that rookie business owners tend to forget about. What fees will you need to pay to license your business? What taxes will you need to pay? Will you need to pay for an accountant, an attorney, or any other professional services? Do you need to purchase a web domain? Hire a branding expert or web designer? These startup and operating expenses often don't make their way onto a traditional balance sheet, but the costs can quickly add up.
A business mentor within your industry can help you to identify hidden operating costs that may not initially come to mind. Contact SCORE or your local small business development center for information about being paired with a business mentor.
Keep Your Eye On the Bottom Line
Although it does take some money to make money, too many business owners set themselves up for failure by accepting this truth as license to make frivolous business purchases. Just because some basic operational expenses are required, doesn't mean you shouldn't be doing everything possible to keep those costs as limited as possible.
The mistake of overspending is most often made by passion-based entrepreneurs. Because these business owners love what they do and often have little business background or education, they can too often spend based on a presumed need without recognizing the impact on the business's bottom line.
If you want your business to make money, you have to decide that profitability is your priority. That means expenses are determined based on what will increase revenue and profitability, not on what would be nice to have.
Analyze Costs and Benefit
Every expense your business incurs--from rent, to inventory costs, to web design and marketing spend--is a cost taking away from your bottom line. The amount of money you gain for each dollar spent in a particular category represents a benefit to that cost.
To perform a cost-benefit analysis for your business expenses, list and estimate all the costs within each area of your business, then list the financial benefits for each expense, and assign a dollar value to each. For each expense, subtract the cost value from the benefit value.
Some operational expenses, such as inventory for a retail store or employee wages for a service-based business, have a clear and direct cost-benefit. For other expenses, such as equipment purchases or marketing costs, the cost-benefit link will be less straightforward. But for every dollar you choose to spend on your business, your job is to determine how that expense will benefit your bottom line. If an expense has no measurable benefit, you may need to reconsider its necessity.
Even with a great business model and a keen eye on managing expenses, most new businesses operate at a loss for at least the first year. The amount of time it takes to become profitable will vary widely by industry, growth rate, revenue, and how you've managed your expenses.
Performing a breakeven analysis will help you determine the point at which your business will reach profitability. Use this formula to calculate your company's breakeven point:
Breakeven point = fixed costs / (unit selling price--variable costs)
Yes, it does take money to make money. Just remember this is a business reality, not a quip to throw around as you charge that second bottle of Dom Perignon as a "business expense." As a business owner, every dollar lost to unnecessary expenses ultimately comes out of your pocket--so make sure the money you spend is actually making you money in return.