Cash Burn Rate: Strategies & Examples
Learn how to analyze and manage cash burn rate for your business success. Discover key financial metrics, forecasting techniques, and strategies to improve cash flow and ensure sustainable growth.
Cash Burn Rate: Strategies & Examples
Cash burn sounds like a painful experience, and it can be if you don't keep your business spending under control. There's little doubt that the goal of any business is to generate more cash than you spend, but operating expenses and "smart investments" can quickly get out of hand.
Understanding how quickly your business uses up cash reserves is vital to business sustainability. Sure, you have to spend money to make money, but you can't sustainably run on negative cashflow. Understanding your cash burn rate and developing a strong expense management strategy is essential to controlling expenses.
Understanding Cash Burn Rate
If you've been running a business for any amount of time, you've probably experienced periods of negative cash flow. After all, a startup has little or no revenue to work with at the very beginning. Still, spending more than you earn for extended periods of time is usually a sign of cashflow mismanagement that can quickly lead to business failure.
Your cash burn rate is the rate at which you use up your company's cash reserves during a specific period of time. In the most basic sense, it's a calculation of your operating expenses and how they relate to your revenue. Cash burn rate is one of several financial metrics that help businesses keep track of spending and improve overall financial health.
There are two main ways to calculate the burn rate:
- Gross Burn Rate: This metric is a direct reflection of your operating expenses. It's composed of all business expenses, including administrative costs, building rent, staff salaries, shipping, cost of materials, etc. It's typically calculated monthly by adding all of your business expenses.
- Net Burn Rate: This calculation enables you to use your gross burn rate to determine the rate at which your company is losing money. It's derived by subtracting your monthly operating costs from the revenue generated within the same time period. If your net burn rate is negative, you're spending more than you're earning. It’s fairly common to have a negative net burn rate when a business is getting started, but at some point, this will need to turn positive or the business will need to look for additional ways to get investments to prolong the runway.
Importance of Cash Flow Management
Whether it's a fledgling startup or a large conglomerate at the height of success, every business needs a solid strategy for managing cash flow. There is no point during a business lifespan when "just winging it" is a good idea. You can make more informed investment decisions by knowing how much money is going in and out of your business.
Cash flow is the balance of cash moving in and out of a business during a specific time period. It's essential to keep a close watch on this movement to understand how much money you can afford to spend wisely. Effective cash flow management gives you a comprehensive view of revenues and expenses so you can ensure you have enough funds to pay your bills and still make a profit.
Analyzing Burn Rate for Startup Success
Startups usually aren't in a position to generate positive revenue and face changing expenses due to the cost of growth. While these factors make analyzing burn rate more complex, they also make the consequences of high burn rate more impactful. Twenty-nine percent of startups fail because they run out of money. Keeping track of your burn rate can help you avoid following in their footsteps.
Startup financials are substantially different than those for an established business. Startups depend on investors for incoming cash flow and spend increasing amounts of money to acquire new customers and establish a place in the market. Analyzing burn rate enables company founders to estimate the capital they'll need to raise to reach the next stage of the journey.
While established companies generally seek ways to decrease the burn rate, startups often expect it to increase. This leads to faster growth than would have been possible with a lower burn rate which will allow the company to reach growth goals at a faster rate.
To be clear, a high burn rate isn't a free pass to go on a spending spree. In fact, early growth stages often require a company to be even more cautious about spending. From new equipment to payroll, you'll need to figure out how to maximize every dollar you spend.
Cash Flow Forecasting Techniques
It's time to get your crystal ball ready because effective cash management requires you to predict the future. You need to foresee how you can pay your employees' salaries, bills, and taxes on time while making investments that will help grow your business. Luckily, this isn't quite as complex as a magic trick. Cash flow projections are a combination of assumptions and tracking financial KPIs.
There are two basic methods of cash flow forecasting. Direct forecasting is the process of integrating data from bank accounts, accounts payable, payroll, and accounts receivable to make well-informed assumptions about short-term future cash flow. Indirect forecasting requires you to use past financial data to make educated guesses about the future.
These techniques are commonly used in cash flow forecasting.
- Tracking cash: Monthly tracking of cash sources, uses, and the factors that affect cash flow and how cash is used will help you recognize a pattern for informed forecasting.
- Calculate an operating budget: Using a combination of historical data and projected trends can help you create realistic expectations for future expectations. Operating budgets focus on day-to-day spending.
- Use automation tools: Accounting forecasting software will decrease the potential for human error.
Strategies for Improving Cash Flow
Business growth means increased cash flow, right? Not necessarily. Remember the costs of growth encountered by startups?
Often, the profits of growth take time to catch up with the costs. Improving your cash flow to match your spending usually requires an examination of internal processes and seeking more funding. Using any or all of these solutions can help you improve cash flow.
Increase Your Efforts to Get Paid
Accounts receivable are your payback for informed business decisions and hard work. Yet, invoices without payments aren't improving your cash flow. There are several ways you can incentivize your clients to make payments on time. Begin by sending invoice reminders to your busy clients before payments are due. A friendly reminder will keep you top of mind, and help clients get their payments out on time. Take your efforts up a notch by offering discounts for customers who send in payments early. This can be especially helpful when cash flow is constricted and you need extra cash to get bills paid on time.
Cut Business Costs
You can't escape operating costs, but you can take steps to reduce your spending. Most businesses don't need full-time employees for every business function. By outsourcing services like IT management, accounting, human resources, etc., you can save on personnel and administrative costs.
Seek New Funding Options
Every growing business needs access to capital. During periods of rapid growth, you may need additional sources of cash flow. There are several external forms of external financing you can consider. If your company is a startup or expanding into new product categories or markets, seeking venture capital from investors can increase your spending power. Connecting with lenders is an excellent way to ensure you have access to money when you need it most. Commercial loans can come in the form of lines of credit and flexible loans.
Make Payments Easy
Every barrier to making a payment is a reason for your clients to put off taking care of your invoice. By providing as many easy payment methods as possible, you improve the likelihood of timely payments. Start by providing multiple payment methods to make sure your customers are comfortable with their options. This should include online payments, mailed invoices, autopay, and payments over the phone. Consider sending out email or SMS invoice reminders with a convenient link to instantly make a payment.
Managing Cash Burn in Challenging Times
Economic downturns often cause a drop in revenue. When you experience decreased revenue without decreased spending, your cash burn rate will increase. This can lead to constrained cash flow that could force you to take on unexpected debt or even close your doors.
During challenging times, it's essential to monitor your cash flow more closely and take proactive steps to avoid excessive losses.
- Monitor your spending and identify areas where costs can be reduced or eliminated. For example, outsourcing administrative tasks could be less expensive than hiring additional employees.
- Create a financial plan to help you address changes in cash flow.
- Explore alternate revenue streams (like adding new service offerings or expanding into new markets) to increase cash flow.
- Seek alternative sources of funding and make connections to ensure you'll have access to funds when you need them.
How Decimal Can Help
Every business is different and needs to be able to control spending in the way that makes sense to them, but if you're juggling costs to make payments on time, your financial management strategy has the potential to jeopardize your business's success. Whether you're looking for ways to scale your business or get bills paid on time, we can help. Learn how Decimal can help you implement the right procedures and technology to manage expenses at scale before spending gets out of hand.