This article was originally posted here on Early Growth Financial Services’s website.
From a semantic standpoint, it boils down to the amount of time a company can continue general daily operations before exhausting the “cash” it has on the books and on-hand. Cash burn is most frequently expressed as a percentage: how much does it cost to operate the company – general and administrative including HR and legal, production, fulfillment, everything, in dollars? – versus revenue the company brings in for a given time period.
Below you’ll find everything you need to know about cash burn, from the mechanics to investor considerations, as well as tips for calculating cash burn, reducing it, and ultimately extending your company’s financial runway (a.k.a. “time to live”).
Mechanics: how to calculate cash burn rate
Total revenue vs. total expenses is fairly straightforward, but what if you aren’t bringing in any revenue? Let’s break that down: say you started your business with $50,000, and your operating expenses are $10,000 a month. You would need to start earning revenue by your fifth month or else you’d be sunk.
The financial nuts and bolts:
- How much money did you spend versus how much money you brought in Example: Burn was 30% of revenue in the last year.
- Gross burn: how much money did you spend?
- Net burn: the money you brought in minus the money you spent
Investor considerations: what they want from you
- Reports on all money you’re spending in a given time period
- Reports on percentage burn rate per month and per year
- Regarding the runway: from an investor’s perspective, if cash in the bank plus money coming in provides a nice buffer, then a higher burn is okay.
- Opposite: spending every bit of money coming in means no wiggle room, then the company is at risk and investors will want to discuss this with you.
For most early-stage companies it’s typical for a burn rate to be higher. “Pre-funded” (bootstrapper) startups are often notorious for spending more than they bring in which can create some interesting dialog in board meetings. Your company board will expect regular updates on this number. If there are any substantial changes to your cash burn rate (e.g. unexpected expenses, loss of revenue) you’ll want to communicate that to your company board as soon as possible.
3 tips for reducing cash burn
- Be prepared to pivot quickly.
It can be easy to get hung up on a brilliant idea. But, sometimes, no matter how brilliant the idea, you need to ditch it. Don’t start throwing good money at supporting something that isn’t helping you to turn a profit. Once you start going down that road, it can be hard to turn around.
- Forecast, re-forecast, repeat.
Regularly monitoring your cash burn rate is essential for keeping business health in check. You will produce financial forecasts as part of the funding process; we also recommend running the numbers often to ensure you’re accurately accounting for fixed and variable costs at all times.
- Consider outsourcing core functions.
By engaging experts who are familiar with everyday business functions like Human Resources and Corporate Governance, you can save time and money. This is particularly helpful on the financial and accounting side. Look for resources with expertise around investor expectations, asset management, and the logistics of managing funds for an early stage business so you can focus your in-house time on growing the business.
For more information on managing cash burn and growing the financial runway for your startup business contact one of our finance experts today.
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