What is Cash Burn Rate? How the cash burn rate is the key to sustainability

What is Cash Burn Rate? How the cash burn rate is the key to sustainability

Do you know how much money you have on hand? How about how much cash did you use last month? Last quarter? Do you know how much money you will have left after this month?

If you don’t have quick answers to these questions, you’re putting your business at risk. Cash is the blood of business and knowing where you are and how you use it is vital to maintaining a healthy business. Sure, your business might be profitable on paper, but without enough money to cover expenses, you could still be on the verge of closing.

What is Cash Burn Rate? How the cash burn rate is the key to sustainability

Now don’t worry, there are some easy ways to study and track your cash flow. We’re talking money burn rate and runway.

What is the money burning rate?

The cash burn rate is the rate at which a company spends its cash reserves or cash balances. It is essentially a measure of negative cash flow, usually recorded as a monthly rate. For example, if you list your cash burn rate of $250,000, then you are stating that your business is spending $250,000 in a given month. It can also be observed day-to-day or weekly if a crisis arises and the use of cash increases to keep your business afloat.

Why is the rate of burning money important?

When you think about the rate at which you burn money, you ask:

  • How quickly do I use my cash reserves?
  • Is my money moving in a positive direction?
  • Am I creating a healthy balance sheet through positive cash flow?
  • How soon will I run out of cash, based on my current spending level?

Typically, you start with these questions to help determine the overall health of your business. How much cash do you have to cover necessary expenses, pay off debt, and leverage for growth purchases. In short, you want to keep track of how resilient your business is so that you are not surprised by a sudden shortage of cash in the bank. A good rule of thumb when considering cash flow is that if a business burns money too quickly, it risks bankruptcy. On the other hand, if a business burns money too slowly, it may indicate stagnation in growth or a lack of investment in the future.

Cash burn rates are especially important for startups and small businesses in the early stages of growth. More often than not, start-ups are not profitable yet, especially in fast-growing tech industries. It can take anywhere from a few months to a few years to achieve profitability, meaning you’ll need to keep a close eye on your cash and funding to manage costs.

Now burn rate is still important for businesses that have achieved profitability. It is vital to crisis planning, helps you identify sales and revenue problems, and validates your position when seeking additional funding. In all of these situations, having control over the current situation, knowing how you are using cash, and being able to make adjustments are all key to growing your business.

How to calculate the rate of burning money?

To calculate the cash burn rate, you need to open the cash flow statement. This will show your cash position at the beginning and end of a given time period, usually monthly. Here’s how you can use your application to calculate your cash burn rate.

Current burnout = cash balance last month – cash balance this month

To determine the burn rate for a given period, you find the difference between the opening and closing cash balances over a period of time, say a quarter. Then divide the amount received by the number of months in the selected period. The result is a monthly value.

Monthly burnout rate = (cash balance at the beginning of the period – cash balance at the end of the period) / number of months in the period

Cash burn rate example

For example, let’s say a company started last quarter with $200,000 in the bank and ended with just $110,000. This is a loss of $90,000 in cash in three months—a burn rate of $30,000 per month.

In terms of a cash runway, this suggests that the company now has just over three months of cash or cash on hand. They need to lower their burnout rate and get positive cash flow quickly. If it is helpful at this stage to see a sample cash flow statement, you can download our sample cash flow statement PDF or spreadsheet for free.

Now that you know your rate of burning money, you can see how long your current rate of burning will be sustainable. By calculating your money runway.

What is a cash track?

Your money runway is how long you can run out of money at your current burning rate. When your money path ends, you run out of money and time.

The typical pattern for startups is to get funding, use that money to grow the business, and then aim for positive cash flow before the money runs out. This is a big problem for funded startups, especially if you are working with venture capital or angel investments.

This same metric is useful for mature businesses as well. How fast are you increasing your cash reserve? Are you strategically investing this money to fund faster growth? Whatever your plans, be sure to keep an eye on this metric to make sure you’re reaching your goals.

How to calculate the money runway?

Finding your cash runway depends on knowing your monthly cash flow. Other than that, all you need to know is the total amount of money you have in your reserves. To calculate your money runway, use the following equation.

Cash Runway = total cash reserve / burn rate

To calculate your cash reserve (how much time a company has before it runs out of cash), take the balance of money left in cash reserves and divide it by the burn rate. For example, if $200,000 is left and the burn rate is $50,000 per month, it will take the company 4 months to run out of cash.

Which is better: high or low money burning rate?

It is often better to have a negative cash burn rate. This means that you are building up your cash reserves, not spending them. Of course, there are cases where investing your money in growth is a good idea: startups, obviously, but also start-ups that are trying to grow. Just make sure you plan on burning money and then track your progress.

If you use up your cash reserves faster than expected, you may be in trouble.

How to reduce the rate of burning money?

If the rate of burning money is higher than you want, changing the numbers is quite simple. You need to increase your incoming money, decrease your outgoing money, or both. Here are some ideas how to do it:

1. Increase your income

Look for ways to increase traffic, drive more leads into your funnel, increase your conversion or close rate, or raise your prices. An increase in sales should lead to an increase in cash receipts.

2. Cut Payroll Costs

For labour-intensive businesses, delaying hiring new employees, laying off non-essential workers, or limiting benefits can result in significant savings. However, make sure any reductions are reasonable and sustainable.

3. Reduce your direct costs

For low-margin businesses, finding ways to minimize unnecessary inventory of raw materials and other direct costs can make a big difference in cash flow.

4. Reducing or postponing other expenses

Take a close look at your budget. Are there any expenses that do not contribute to the success of your company?

5. Ditch unprofitable sources of income

Growth-driven companies often offer non-essential products or services that don’t pay off. Pause any non-revenue offerings to help manage your burn rate. You can always restart later.

6. Encourage cash sales

Selling for cash is great: you get the money right away, rather than waiting for it. Make sure you offer credit terms selectively and sensibly, and don’t just convert immediate transactions into deferred ones.

7. Bill earlier and raise money faster

When you offer credit to clients, be sure to bill them in a timely manner. Clearly state the terms of the loan and take appropriate action to collect payments if they fail to pay on time. Adding a late payment fee can also encourage more timely payments.

8. Pay bills slowly

Unless there’s a discount or other incentive to pay early, don’t pay your bills faster than you need to. Take advantage of agreed payment terms to hold cash longer.

9. Sell excess inventory

The extra inventory is still valuable, but it’s not as useful as having an equivalent amount of cash. Consider offering promotions or discounts to sell what you don’t need for regular sales.

10. Consider using a factoring service

Factoring is a financial service in which a business sells its accounts receivable to a third party at a reduced rate. If you can’t get customers to pay their bills on time, then a service like this might be worth considering.

11. Postpone big purchases

If cash is tight, with a large capital outlay, you may have to wait, unless it’s an investment that starts to pay off immediately.

12. Consider Debt Refinancing

Using too much money to pay off debt? Ask your lenders about refinancing options with lower payments.

13. Raise additional funds

If you have done everything you can to influence your incoming and outgoing cash flows (your cash flow), but the burn rate is still too high and, most importantly, you are confident that your business can be successful, you may have to do more. fundraising. Be sure to do this as early as possible, as a business that runs out of cash may seem too risky to potential lenders.

Where to find the burnout rate in LivePlan

If you’re looking into software options that can help you manage your cash flow better, you might want to check out LivePlan. With it, you can easily track your financials, update your forecasts, and easily view your burn rate, starting with a holistic view of each metric on your business dashboard. Here’s how you can find out the cash rate in LivePlan.

Once you are logged into your LivePlan account and are viewing the dashboard, click on the “trends” option in the navigation. Click on your current metric (probably Revenue) to open the menu and select your cash burn rate from the Money Metrics category. This will give you a visual and statistical overview of your burn rate over a period of time, with the ability to customize the periods you want to view.

The benefit of using LivePlan, besides knowing your burnout rate, is that it also tells you how your burnout rate is performing compared to the previous period, year, and your forecast. This makes it easier to check if you’re making positive progress in optimizing your burn rate or if you need to make further adjustments.

Keep track of your cash flow

Cash burn rate and runway are relatively simple formulas, but they are vital to building and maintaining your business. The better you manage your money and understand your overall position, the better prepared you will be for growth or a crisis. To learn more about simple business concepts, check out these articles on direct costs, net income, operating margin, accounts payable and receivable, cash flow, income statement, balance sheet, and expense budgeting.

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