Projecting Your Opening Expenses and Start-Up Capital Excerpts from the chapter, "Projecting Your Opening Expenses and Start-Up Capital" by Willard Dickerson, Jr. from Manual on Bookselling Over the past two decades, competition within the bookselling industry has intensified. The individual bookseller has had to become an informed, well-trained professional in order to prosper, or even to survive. At the same time, the amount of capital needed to open a store has skyrocketed. Launching a small- sized store with a small selection of books for a small amount of money is almost a sure way to guarantee failure. Though opening capital needs can vary somewhat depending upon size, type of location, and leasehold improvements needed, average costs for some categories and basic minimum costs for other categories are known and can be used to predict with reasonable accuracy the total amount of needed capital. This chapter will discuss capital needs and sources. Preopening Capital For a sample new store, we will use an average size of 2,000 square feet of space that does not require þbuildoutþ (that is, floor, walls, wiring, plumbing, etc.). space.) On this space will be performed minor renovations, generally referred to as þleasehold improvements,þ and into this space will be placed furniture and fixtures, inventory, and operating equipment. Well before the store opens for business, personnel will be paid, training and convention costs will be incurred, supplies will be purchased, deposits will be made, and various operating expenses will have begun. Consequently, a significant amount of preopening capital will be needed. Opening Inventory Inventory costs can vary widely depending upon a number of factors such as: Type of Book Selection: Price point and ratio of hardcover to trade paper to mass market; Depth/Breadth Image: Number of titles and number of copies per title; and Store Layout: Casual/roomy vs. crowded/floor-to-ceiling. Even with these variables, however, an average amount of inventory at cost can be estimated. If all of the most expensive options are chosen, an opening store can accommodate as much as $100 per square foot of inventory, whereas an opening store choosing lower cost options could open with as little as $25 per square foot. An average and reasonable amount for new store planning is a figure close to $50 per square foot of selling space. Given our model of 2,000 feet of total space with 90 percent allocated for selling space, opening inventory costs are estimated at: 1800 square feet x $50 per square foot = $90,000 Leasehold Improvements The cost of preparing space for a new store covers a wide dollar range because the types and preexisting conditions of space vary so greatly. The most expensive situation is one in which the bookstore becomes the first tenant in a new mall where complete new buildout is required. Similarly, the need to completely renovate space in an older building with a different type of preexisting use, often requiring considerable adaption to newer building codes, is also extremely expensive. By contrast, the least expensive preparation costs are incurred when taking over the space previously occupied by another retailer where only a coat of paint, new rug, and slight modification of nonload-bearing walls is necessary. Another variable is the degree of participation from the building owner. The owner may pay for a large part of the renovation costs and then charge higher rent over the term of the lease, as opposed to requiring the new tenant to bear the cost of renovation while then charging a lower lease rate. Over a ten-year period, the total combined cost of leasehold improvements and rent to the bookstore owner may be the same, but the amount of capital needed up front may vary significantly. Based on the experiences of a large number of stores, we can estimate about $10 per square foot as an average amount likely to be spent on space improvements. Thus, for our model store the cost is: 2,000 square feet x $10 per square foot = $20,000 Furniture and Fixtures Although there are some relatively inexpensive bookstore fixtures made from steel or varying qualities of particle board, the kind of solid and attractive fixtures needed to display books in an appealing manner are by no means inexpensive. Even good quality fixtures do vary substantially in price, however, depending on the level of custom design required and the distance to the store from the manufacturing source. Attractive, good-quality, ready-made fixtures are widely available from competitive sources. To equip a store completely with new fixtures will cost somewhere in the vicinity of $15 to $20 per square foot. Assuming the higher figure, the cost of fixturing our model store would be: 2,000 square feet x $20 per square foot = $40,000 Without sacrificing quality, used fixtures can often be obtained - with a substantial reduction in cost - either directly from a bookstore in the process of renovating, relocating, or closing, or from a used-fixture company. Equipment At a bare minimum, a bookstore will need at least one electronic cash register; however, given the number of titles and vendor sources that must be managed in today's bookselling enterprise, it is fair to say that a computer system for inventory control is almost always necessary. Once a commitment is made to acquire a computerized inventory system, the same equipment can be used for sales transactions, accounting, and data-based marketing functions at very little extra cost. Computer systems that can perform all of the above functions are available from numerous competitive sources, ranging in price from about $8,000 to $24,000 depending on the size, quantity, and complexity of functions and transactions anticipated. Complete adequate beginning systems for new smaller stores that can be expanded easily without having to buy a new software package or all new hardware when increased capacity is required are available for about $8,000. Some additional equipment for credit-card transactions, outside store sales, shipping and receiving functions, etc., is also needed, bringing the total average amount to be allotted for new store equipment to approximately: $15,000 Professional Consultants For store functions that will be performed repeatedly over time, it is best for the store owner to commit the time and expense to learn those functions. If the owner has little or no bookstore experience, he or she may benefit by retaining a þpaid tutorþ or bookstore consultant to teach the new owner the ropes. However, for those functions that are likely to be performed only once or, at the most, once every five or ten years, it is far more cost efficient to hire a professional consultant. These include such areas of expertise provided by an architect or store designer, lease negotiator, attorney, and insurance agent. Sometimes the services of a banker, insurance agent, or even a business planner can be obtained free from organizations such as the Small Business Administration, but even if you have to pay, professional consultants are well worth their cost. On average, the total cost for all paid consultants should be in the neighborhood of: $6,000 Supplies Needed supplies include such mundane items as paper bags, special order forms, a stapler and tape dispenser, bookmarks with hours and phone number to include with each purchase, a hard-copy set or CD-ROM version of Books in Printþ, mailing list sign-up pads, etc., etc., etc. All of these items, especially the first few months' supply of bags, will cost several thousand dollars and should be included in an opening budget: $4,000 Deposits, Registrations, Fees, and Memberships Although most store owners are conscious of the requirement for rental security deposits, they often overlook the need to register with and pay fees to various governmental agencies; the cost of joining local merchants' and trade associations; and the cost of assorted deposits with utility companies, etc. These items can amount to several thousand dollars. The total varies, most significantly by the amount of rental security, but, on average, you should plan to budget about: $6,000 Preopening Salaries The amount of work required to open a new bookstore dictates that at least one person be working full-time for at least 120 days prior to opening, with additional help needed for from two to four weeks before opening. Preopening salaries have a wide range because of the substantial variation in wages paid to both hired staff and owners. For planning purposes, however, the minimum you should budget for preopening salaries is: $8,000 Training and Conventions Most new store owners and/or managers will find professional training programs and trade conventions an essential ingredient in preparation for opening. The cost of attending one each of an ABA Professional Booksellers School and a trade show/convention will, on average, add to preopening costs: $3,000 Grand Opening Advertising It is crucial that advertising, promotion, and publicity be included in your preopening budget, or the best of plans will be derailed for lack of funding. General industry consensus is that a minimum of 2 percent of anticipated gross revenues be spent on advertising for an operating store and that anywhere within a wide range of $5,000 to $25,000 be spent on grand opening advertising and promotion: $10,000 Contingencies The experienced planner will realize that despite careful and thorough planning, something will have been forgotten or, even more likely, something will have cost more than predictedþthus, the need for the budgeted item of contingencies. For new store start-up, with all of the variables and the wide range of decisions that affect cost, a reasonable percent to use for contingencies is approximately 10 percent of the total of other budgeted expenses: 10% of total budgeted expenses Summary of Preopening Capital Needs Opening Inventory $ 90,000 Leasehold Improvements 20,000 Furniture and Fixtures 40,000 Equipment 15,000 Professional Consultants 6,000 Supplies 4,000 Deposits,Registrations, Fees, Memberships 6,000 Preopening Salaries 8,000 Training and Conventions 3,000 Preopening Advertising and Promotion 10,000 Subtotal 202,000 Contingencies (~10%) 23,000 Total Preopening Costs* $225,000 * Prior to consideration of anticipated first-year operating loss. First Year's Operating Budget and Capital Needs Once a facility has been renovated, the staff trained, equipment, fixtures, inventory, and supplies purchased and installed, the doors of the store are ready to open and the first book is ready to be sold. Before any of this happens, however, a clear and careful budget of anticipated revenues and expenses for the first year should be prepared. With the many stores I have guided through the opening process, I have suggested a budget giving low, medium, and high projections, so that plans can be made and action anticipated for various revenue and expense scenarios. Although anticipated first- year's sales can be projected from the experience of other bookstores, the range varies so widely by type of location that it would be too cumbersome to outline here the complete range of revenue possibilities. By referring to the American Booksellers Association's ABACUS Expanded financial profile, however, operating data for a wide range of bookstores by size, region, and type are available. For purposes of this analysis, numbers that fall near the mid-range of sales projections and expenses in the ABACUS study will be used. Average First-Year Bookstore Projection (Assume 1,800 Square Feet of Selling Space) Low Medium High Sales per Square Foot $ 100 $ 125 $ 150 Sales Revenue 180,000 225,000 270,000 Less: Cost of Goods* 108,000 135,000 162,000 Gross Margin 72,000 90,000 108,000 Less: Expenses Wages (1st year, 18%) 32,400 40,500 48,600 Rent ($14/square foot) 28,000 28,000 28,000 Advertising 3,600 4,500 5,400 Insurance 1,500 1,500 1,500 Postage 1,000 1,200 1,400 Conventions 1,000 1,000 1,000 Supplies 1,200 1,300 1,400 Telephone 1,200 1,300 1,400 Utilities 1,400 1,400 1,400 Taxes, Licenses, Fees 1,000 1,200 1,200 Depreciation 15,000 15,000 15,000 Payroll Taxes 2,500 3,200 3,850 Bank/Card Fees 1,800 2,250 2,700 Professional Services 2,000 2,000 2,000 All Other Expenses 5,000 5,000 5,000 Total Expenses $ 98,600 $109,350 $119,850 Net Profit or Loss ($ 26,600) ($ 19,350) ($ 11,850) * Assuming 40% discount. It can be seen that even under the best sales projection, the first-year bookstore has an operating loss of $11,850; the loss with a medium sales projection would be $19,350; while under the worst scenario there is an anticipated loss of $26,600. In planning capital needs for a new bookstore, the anticipated operating losses during the first year should be taken into consideration. After a store has experienced an operating loss is not a good time to seek additional outside sources of capital, whether or not that loss is quite normal and anticipated. The bookstore owner must plan in advance how the capital depletion from the first year's operating loss will be covered. Cash-flow analysis gives a more accurate picture of what portion of the first year's bottom-line loss must be replaced as working capital. For purposes of illustration, however, let us assume that the medium sales projection's loss of $19,350 needs to be replaced. If this amount of capital is added to the preopening capital, the total amount of capital to be raised is: (Preopening Capital) + (Year 1 Operating Loss) = (Total Capital) $225,000 + $ 19,350 = $244,500 Sources of Capital <>Occasionally an individual is able to finance a new bookstore completely from his or her own personal resources, but in most cases the individual will have to find additional outside sources. Sometimes several parties will band together to pool the resources they have been able to accumulate. The three main forms of ownership structure are the sole proprietorship, partnership, and corporation. This section will assume a corporate structure, dependent upon multiple sources of capital, and will explore these various sources in order of importance and magnitude. Equity/Inside Personal (Internal). Equity, as opposed to debt, is invested capital as opposed to borrowed capital. The individuals supplying the equity are synonymous with ownership, which has the authority, through the election of a board of directors, to hire management and to set policy. Equity, or invested capital, earns no guaranteed interest or return. It bears primary risk. If the store earns a profit, equity capital shares in the profit; if there is no profit, there is no return. It is unlikely that anyone else, especially a lending institution, would be willing to invest capital in a new venture, either in the form of equity or debt, unless there is a personal equity investment first. Equity/Outside Other Sources. Once the individual has demonstrated confidence by investing personal capital, the next best source for capital is relatives and friends. As the progression continues and even more confidence in the new bookstore is demonstrated, it follows that other parties, often acquaintances or former business associates, will be interested and willing to invest in the new bookstore. Long-Term Debt Debt is borrowed capital. It bears a fixed, guaranteed interest rate and must be paid back over a specified period of time. Sources of borrowed capital do not exercise ownership authority. The definition of long-term, as opposed to short-term, debt is arbitrary, but in a small business is usually considered to be three years or longer. After equity capital, long-term debt is the next most important source of operating capital, because the principal does not have to be paid back in the early years of the store when cash flow is critical. Current interest rates fluctuate depending upon economic conditions well beyond the scope and influence of a bookstore and, although there is some room for negotiation within a narrow range set by the lending party or institution, prevailing rates must usually be accepted. Equity-to-debt ratio: A sound principal that should be followed by a new bookstore, given the general economic parameters under which bookstores operate, is that the ratio of equity capital to debt capital should be kept at no less than two-to-one. A ratio less than two-to-one indicates that too much interest expense will have to be paid, thus placing greater pressure on the cash flow. The ration of equity to debt can safely change in subsequent years after other expenses become lower as a percentage of gross sales, but should be guarded carefully during the first two years. Vendor Financing A new bookstore often must pay for the first order from a vendor in advance. Sometimes, however, depending on a variety of circumstances, the vendor will allow certain payment terms that extend the amount of time in which the bookstore is allowed to pay. This, too, has the effect of raising working capital. Memberships and Gift Certificates There is also the possibility of selling special gift certificates and memberships; in the store, even before the store is open. This, in effect, places capital into the store before operating expenses are incurred, reducing the amount of capital needed before opening. The benefit is short-lived, however, as usually within the first year the memberships and certificates have been redeemed. Sweat Equity When the bookstore entrepreneur is able to work for some time without drawing a salary, it substantially reduces operating expenses, which in turn reduces the estimated first-year's operating loss. This, of course, decreases the necessary amount of start-up capital which, in some cases, has the effect of raising more capital. Swap: Merchandise for Service Though not as frequently used as other alternative sources of capital such as sweat equity and vendor financing, the possibility of trading merchandise for various services needed in the renovation process does offer a benefit to the store. Any merchandise accepted by the tradespeople as payment costs the store only 60 percent of the retail value, thus reflecting a 40 percent lower cost to the store. In summary, the sources and structure of needed capital can be illustrated by the following diagram: