Whether you are starting a franchise or an independent business venture, certain expenses before the opening day will occur. So, we will explain to all aspiring entrepreneurs what are pre-operating costs and what are characteristics and examples of it.
- Pre-operating costs incur before the opening day of the business.
- Before a business sells its first product or service, all expenses made in that period fall in the category of the pre-operating costs
- Pre-operating costs can’t be considered investments; only operative costs are investments.
- Legal fees, office furniture, market research, utility, training, and accounting expenses all count as a pre-operating costs
What are Pre-Operating Costs?
Pre-operating costs are costs incurred before a business is launched or before a new initiative of an already existing business is launched. They can only be regular business investments agreed upon under the standard accounting principles.
Characteristics of Pre-Operating Costs
These types of costs are generated before the beginning of operations.
Pre-operative costs include money you spend before selling your first product or service. The money you spend after your services have begun is known as operative costs or capital.
Pre Operating costs are not investments
Pre-operating costs are always going to be expenses. They cannot be considered investments because, at the time of expense, the company or the new initiative doesn’t exist.
Investments can only be made to businesses or initiatives that already exist. However, the money spent looking for potential investors can be considered a pre-operating cost.
Must be necessary expenses
Since pre-operating costs sometimes can be subjected to tax deductions, they must be essential expenses. This is enforced to make sure businesses don’t evade taxes.
It would be wise for entrepreneurs to check what is and is not tax-deductible.
They are subject to a tax deduction.
These tax deductions are awarded to support new businesses or initiatives and ensure they have a chance of survival in a competitive market.
Must be classified correctly
This is also concerning tax deductions. Careful, correct classifications help reduce tax fraud.
Examples of Pre-Operating Costs
Before a business is launched, it needs to have the proper permits, licenses, NDAs, and drafted contracts, among other legal requirements.
Multiple lawyers may be needed to get all of this sorted out. Make sure the lawyers are familiar with local law to avoid any mix-ups. Some permits and licenses require you to pay a registration fee upon submission.
Expenses needed for materials
The office space you’re going to use needs supplies. These can be chairs, tables, pens and pencils, air conditioning, internet connection, and interior decorations. Factories may need machinery and storage space.
Employee training expenses
Your employees need to be trained before the business is launched. You will spend money on supplies, transportation, facilities for the trainees, and other administrative costs. The payments for employees before the company or initiative is launched can also be considered.
Finding and renting or buying a space for your business will have pre-operating costs. Traveling to examine spaces, discussions with owners, and evaluating the spaces will cost you money.
Preparing the space in a way best suited for the business will also cost money that can be considered a pre-operating cost.
Market research expenses
You may need to hire a professional for thorough market research and evaluation. Figuring out your market and how to communicate with them in their language will be important when planning future strategies and, subsequently, the success of your business.
Having a clear marketing plan is also essential when it comes to attracting prospective investors.
Promotional and marketing expenses
Letting your potential customers know when you’re starting a business and what your business is all about is an essential task.
You can tease the release of a product or service on social media or hire a celebrity to represent your brand and create buzz around your product. You can also take more traditional routes like e-mail marketing or TV advertisements.
Gaining the interest of potential investors
Potential investors are essential to the longevity of your business in the long run. Their expertise might come in handy when running your new business.
How do you get them interested? You must have a solid business plan, have a detailed marketing plan, be ready to explain these plans to prospective investors, and ask friends and family who believe in your plans to be investors.
The costs you will incur doing this can also be listed under preoperating costs!
Since pre-operating costs can include producing products to be sold, the money you spend producing and perfecting said product is counted under pre-operating costs.
Supplies can be raw material, packaging material needed, etc.
Hiring an accountant as soon as possible is a wise decision. This can be before the business is launched because you will be dealing with money way before your business launches.
Hiring an accountant will ensure you’re conducting your money legally, reassure your potential investors, make paying taxes in the future a breeze and keep track of your accurate profit will be more effortless.
Buying computers and machinery necessary to run your business, as well as the cost of software and other programs, are counted under pre-operating costs.
Meeting and planning costs
The money spent by partners to meet and plan the direction, plans, and strategies of the business can be included as pre-operating costs.
Money spent on essential utilities such as water and electricity is accounted for under pre-operating costs.
Why should you segregate pre-operating costs?
It will give you an idea of how much starting up a single branch costs if you’re planning on franchising your business.
A detailed record of pre-operating costs will help the franchisee determine if they want to invest in your franchise. Even if you’re not franchising your business and you’re just expanding it to other states, this manual will be very helpful.
How much pre-operational cost will a business need?
What counts as a pre-operating cost can change from industry to industry and state to state, and it’s essential to check with a qualified local lawyer and accountant before commencing any business planning.
For example, opening a single coffee shop will have a pre-operating cost of $80,000-$300,000, but opening a pizza shop will have a startup cost of $95,000-$2.5 million.
Also, opening a franchise such as Mcdonald’s will demand more properating costs than starting an independent pizzeria.
Do your research well, and good luck!