Burn rate is the measure of negative cash flow in startups.
In simple terms, it’s how much cash you’re using over a given period, typically one month. It measures how long your business can continue to operate.
If you’re super early, funded, and unprofitable, you’re burning through cash every month to pay salaries, rent, and other expenses. Reducing burn rate extends your runway, which indicates the amount of time remaining to become cash-flow positive.
When cash is plentiful, founders can get lulled into thinking that there is always more funding available. Just turn the faucet on when the accounts are getting low. But a downturn or other economic pressure may mean that the next VC cash injection is further down the road.
Here are the five key metrics to properly track to help you reduce burn rate.
Higher revenues and more money coming in normally reduce burn rate by increasing the amount of cash in the bank for operating expenses. Finding ways to increase sales through clever marketing or adding additional channels can boost your revenue and improve your burn rate.
But because revenue growth can also mean expenses growth, it’s important to keep an eye on your expenses during this phase.
Sales are an important indicator that customers value your product or service.
But the crucial thing is making sure that you’re collecting customer revenue. Ideally, you receive your customer’s cash before paying your expenses. But at a minimum, your customers should be paying on time.
Small businesses are in a critical situation, with nearly a trillion dollars in unpaid invoices to small businesses. Some of that is natural, a product of payment terms, or shortly overdue customers. But over 80% of that $875 B is 30 days past due.
To improve your accounts receivable situation, set up automation or use an accountant to collect invoices on time. And get rid of customers that aren’t paying according to the agreed terms. You don’t need that.
Your gross margin is essentially how much money you make from selling your products or services after paying the direct costs to deliver those products or services. In order to reduce your burn rate, you will want to make sure your gross margins remain healthy enough to help cover other fixed operating costs. If the cost of your inputs is increasing, your margins will suffer.
For example, if the cost of materials to produce your goods increases because of supply chain shortages, you may need to increase your prices to protect your margins. Having strong consistent margins is critical for managing your burn rate and runway..
How much profit are your products and services generating?
Knowing where your money comes from and which parts are taking the biggest chunks is a critical aspect of financial reporting. A financial system (or accountant) that shows you with relative ease your profit per product/service can help you make critical decisions for your business.
If you have multiple products, is each one pulling its weight? If some aren’t profitable, consider shutting those down in order to focus on the products/services with positive ROI.
Improving cash flow, and even becoming profitable is the best way to reduce, or even eliminate, burn rate. Achieving positive cash flow means your expenses are matched to the level of revenue you’re generating.
Positive cash flow can be achieved through good management of expenses, so get on a budget. Track closely what’s going out and watch for cash flow leaks. When you do find those leaks, plug them.
Do you have subscriptions you’re no longer using? Are there a few expensive employees hanging around who are no longer delivering?
The long-term success of your business hinges on you making smart decisions about your expenses and what you’re spending on.
Beyond managing expenses, setting growth and sales goals can help make sure the business achieves positive cash flow.
Make forecasting a regular part of your business processes. It gives you a much better chance of reaching those sales goals.
For example, when the forecast shows you’ll be coming up short, it’s time to take action and make decisions on how to course-correct to get the business back on track. Pinpoint where the issues in your funnel exist and address problems at their core.
Burn rate is one of the most critical financial measures of a startup. When your business runs out of cash, your options can become very limited.
Working to reduce burn rate through increasing sales, collecting your accounts receivable, and matching your level of expenses to your revenue growth is also the best way to become cash-flow positive.
Working with an accounting partner like Founder’s who focuses on startups and knows their challenges can help you improve burn rate. We help you make quick, informed decisions about what’s going on in your business and how to address it by delivering the right information at the right time.
Click here to schedule a free consultation with an expert from Founder’s today to make sure you’re on the way to cash flow positive.
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