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manuj’s blog

April 22, 2022

Why Cash Burn Rate Is Key to Sustainability & How to Reduce It

why cash burn rate is the key for startups and how to calculate it

To help understand a company’s financial position, investors and business owners look at the burn rate. 

The burn rate is how quickly a new company is spending its capital to finance overhead before generating positive cash flow from operations.

The main purpose of the cash burn rate is to determine the time frame a company has in which to survive or reach profitability. 

If a company’s revenue flow decreases, it should lower its burn rate accordingly. The longer it takes a company to become profitable, the less likely it’s going to survive.

Therefore, when a company has exhausted all of its cash and is not making money, it will either need to secure more investment or sell the company’s assets. Without sufficient financing, it will be forced to close its doors.

What Exactly Is Cash Burn Rate? 

The cash burn rate is the rate at which a company spends its capital. The burn rate is also known as negative cash flow or cash burn, and it’s an important metric for companies to track.

Burn rate is a measurement of how fast a company is spending its money. In other words, it’s the rate at which a company is losing money.

Burn rate is important because it often indicates how long a company will be able to operate without additional capital. Many investors analyze burn rate as an indicator of how well the business is actually doing.

Why Burn Rate Matters – What You Need to Know? 

The term “burn rate” is used in the startup world to describe a company’s negative cash flow. 

As such, the burn rate is primarily an issue for startup companies, which are typically unprofitable in their early stages and generally belong to high-growth industries. 

That means that for every month that goes by, you have less money in the bank than you had before. 

Let’s say you want to scale your SaaS business. Now, you’ll be hiring a lot of new people and buying new software to support that growth. In the meanwhile, you also need to know exactly how much money you have in your hand to support the expenses so that you can plan accordingly.  This is why need to know your burn rate as well. 

Burn rate is often expressed on a monthly basis.

For example, if a company has $1 million in the bank and a burn rate of $50,000 per month, then it can run for 20 months before it runs out of money.

Why does Cash Burn Rate Matter? 

When you are starting or growing a company, it’s important to know how much cash you need to get where you want to go. And how long it will take to get there.

Burn rate provides one way of looking at that question. If you know your burn rate, you can make sure you’ve enough cash in the bank to fund your operations until you reach profitability or some other key milestone.

So what if you have a high burn rate? 

A high burn rate isn’t always a bad thing. It’s expected of many startups because they need funding to hire staff or build out their product before they start selling it. 

However, if your burn rate is too high, you may not be able to raise additional funding because investors will view your venture as too risky. 

It also means that you’ll have less time to turn things around before you run out of money. Your burn rate should give investors confidence in both your ability to control costs and execute your plan for growth

Calculate Cash Burn Rate for Your Company

If you look at your financial statements, you may see something called “net cash flow from operating activities”. This number tells you what your ‘burn rate’ was in the past — it shows how much money you spent during that time frame.

The best way to know your cash burn rate is to forecast the future and understand how much you expect to spend and when. 

In other words, use this number as a measure of how long you have until you need more cash or capital. You can also use it as an indicator of whether your business will succeed or fail by comparing it against other companies in your industry or by using industry benchmarks.

To calculate the burn rate, divide the amount of unrestricted cash plus short-term investments on hand by the number of months until the next round of funding (if applicable).

The formula looks like this: 

Cash Burn Rate = [Unrestricted Cash + Short Term Investments] / Number of Months

In most cases, you need to find out the burn rate of a quarter. For that, you can calculate the difference between the starting and ending cash balances for that timestamp.  Then simply divide the total by the number of months in that timestamp. You’ll get the monthly value.

The formula would look like this: 

Monthly Burn Rate = (Cash Balance at the start of the Period – Cash Balance at the End of the Period) / Number of Months in Period

How to calculate cash burn rate with example
How to calculate cash burn rate with example

An Example of the Cash Burn Rate

Let’s consider the cash flows of a hypothetical company. Suppose that in its first year, it has $10 in revenue and $8 in expenses. This would mean that the burn rate for the company is –$2, since the company is generating negative cash flow (cash outflow exceeds cash inflow).

In its second year, it has $20 in revenue and $15 in expenses. In this case, the burn rate is –$5.

In its third year, it has $30 in revenue and $23 in expenses. The burn rate is –$3.

Since the company is generating negative cash flow from operations, it must raise capital from outside sources to stay afloat. In this example, the company raises an initial amount of $100 from investors after its first year of operation.

In its first year, then, there was no need to calculate a “burn rate” because no capital was raised after operations began. In its second year, however, when the company had –$5 in cash flow from operations and needed to raise an additional $50 from investors to stay afloat, the burn rate was simply:

($5 / $50) * 100% = 10% per month

How to Reduce or Optimize Your Cash Burn Rate?

To keep your business afloat and profitable, you need to know that your cash flow is enough to cover your costs. So if your expenses are more than your cash flow, you’re in trouble.

Here are 14 ways to optimize your cash burn rate. 

1. Improve Your Sales Process

One of the most important things you can do to achieve a low cash burn rate is to improve your sales process. 

If you’re able to close more deals or sell more products with the same number of salespeople, you can improve your cash flow. You should also focus on selling higher-margin products and services.

2. Focus on Productivity

You can improve your overall business productivity by investing in better tools, like CRM software, which makes it easier for your employees to do their jobs and accomplish tasks faster. 

Also, try outsourcing non-core business functions so that you don’t have to hire full-time employees who might not be as productive as someone who specializes in that function. 

Additionally, consider getting rid of underperforming employees who might be slowing down production efficiency.

3. Reduce Your Office Space

If your company has a lot of storage space or office space, consider downsizing. 

Empty offices that are leased, for example, can be an unnecessary expense. You can also get rid of extra furniture this way.

4. Increase Your Revenue

Your business can’t survive without revenue, but if there’s not enough coming in to keep the lights on and pay the bills, you’re going to need to increase it soon. 

Look for new markets to sell products in or try new marketing techniques to win over more customers.

5. Renegotiate Rent and Other Contracts

It’s worth calling up your landlord or utility provider to see if you can get a better deal. 

You might be able to negotiate a discount or deferral payments for a period of time. Just remember that other businesses will be doing this too, so don’t expect immediate results.

6. Cancel Subscriptions and Memberships You Don’t Need

If you’re not using a subscription service or membership, cancel it. It may not seem like much but every little bit helps when you’re trying to conserve cash.

7. Review Your Bank Fees and Other Business Expenses

You might be able to cut out some of your bank fees by changing accounts, negotiating a better deal with your bank, or switching providers. 

It’s worth revisiting all of your business expenses and seeing if there is any you can do without right now.

8. Delay Hiring, or Hire Part-time Workers. 

When you’re really strapped for cash, you might have to delay hiring full-time employees. If you can’t do that, consider bringing on part-timers instead of full-timers. They’ll cost less.

9. Cut Down on Unnecessary Travel 

Travel is one of the most common business expenses. But it’s also one of the easiest to cut down on when money is tight. 

You can cut back by asking your employees to stay in town for business meetings or conferences. Video conferencing and webinars are usually cheaper alternatives as well.

10. Sell Your Extra Stuff

What do you do with the old computers, furniture, or appliances? Sell them! If you don’t need it anymore, and someone else does, there’s no harm in selling it for some extra cash.

11. Reward Your Customers With Credit (Instead of Cash)

Instead of giving customers cash refunds for returned items, offer them store credits instead of cash refunds for returns (just make sure this is clear in your return policy). 

Store credit will still encourage them to come back and shop again, but it won’t hurt your business’s cash flow as much in the short term.

12. Get Rid of Unprofitable Revenue Streams

Take a good look at the products or services you offer and determine how profitable they really are. 

You may find that they aren’t worth the effort and it’s time to cut them from the mix. If you have any products or services that aren’t making money, focus on those that do.

13. Bill Earlier and Collect Sooner

To get paid faster, consider moving to a shorter billing cycle (e.g., weekly instead of monthly), and send invoices electronically so they arrive instantly. 

And offer incentives for customers who pay early or by credit card.

14. Pay Your Bills Slowly

Consider delaying payments as long as possible without incurring late fees or damaging your relationship with vendors. 

This can give you a temporary boost in cash flow while you work on other tactics to improve it permanently.

Summing Up 

If you’re in a position of running a business you need to be concerned with cash burn. You should absolutely track your cash burn rate. 

This calculation will help you figure out how much cash you can afford to spend, which is key to maintaining the sustainability of your business. 

Cash burn is simple to calculate and takes just one column on your financial statement. It’s not just a metric. But it’s also an excellent way to stay on top of how much money your company is spending.

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