Capital takes a huge role in a business’s life. However, before the capital is spent to support the newly established business, it is important to calculate the cost of capital.
What is the cost of capital?
The cost of capital is the cost of funds the company uses to support and finance its operation.
Generally, the cost of capital is divided into:
- Capital expenses: an amount spent by a business to purchase goods in order to expand the company’s ability to generate profits. These purchases such as office equipment, buildings, machines, or vehicles. Most often, the capital expenses are depreciated from 5 to 10 years.
- Operating expenses is an expense to finance a business operation. Operating expenses include inventory cost, marketing, payroll, electricity, and rent. The management has the responsibility to determine how low the operating expenses can be reduced without affecting the operational activities.
The other important point to consider is inventory. The inventory quantity is determined by referring to monthly target.
Calculating business capital
In calculating the business capital, set the inventory based on the monthly sales prediction. Example: your grocery monthly target is IDR 20.000.000. The inventory turnover is 3 times in a month. Means, once in 10 days you need to purchase goods as your inventory. The inventory calculation will be:
Inventory IDR. 20.000.000 x (1-30%)/2 = IDR. 7.000.000
For newly established business, the owner should provide the reserved expenses at least for the first 3, 6 or 12 months. Why the reserved expenses are required?. Commonly, the new business has not earned the determined profit target. The reserved expenses are allocated to support the business activity in its first year.
Here is the example of capital expenses and operational expenses.
For instance, the clothing business owner opens his online store.
Capital Expenses:
– Store Website IDR. 2.000.000
– 1 computer IDR. 3.000.000
– 1 modem IDR. 350.000
– 1 mobile phone IDR. 1.000.000
– Clothes inventory IDR. 7.000.000
Total Capital expenses IDR.11.350.000
Operational Expenses
– Office and warehouse monthly rent: IDR. 1.500.000
– The salary for 3 employees @ IDR. 1.000.000 IDR. 3.000.000
– Electricity charges IDR. 300.000
– Internet charges IDR. 400.000
– Pulse charges IDR. 250.000
Total Operational Expenses IDR. 5.450.000
To calculate your reserved expenses for the first 3 months: IDR. 5.450.000 x 3 = IDR. 16.350.000. The total business capital to open your online clothing store is:
Capital Expenses + Operational Expenses
IDR. 11.350.000 + IDR. 16.350.000
= IDR. 27.700.000
