Understanding how to manage cash burn can help startups better assess their ability to pivot, grow and secure funding from investors. This measurement of the amount of cash a company is spending (net of revenue) can indicate health or be a warning sign for investors.
Cash burn is a metric that startups must track closely, especially before reaching profitability.
Let’s look at how to calculate cash burn and its link to your business’s financial standing.
Cash burn is a concept companies use to measure how much cash they consume.
Cash management can be challenging because startups often spend money on marketing and customer acquisition before generating revenue. Too much cash going out could eventually cause a business to run out of money.
Cash burn is an essential indicator of a company’s financial health because it shows how much cash you have on hand compared to how much you’re spending each month.
Cash burn shows cash flow health, and careful monitoring can give insight into your business’s funding needs and the efficacy of your marketing plans. A low cash burn rate typically lowers the risk of running out of capital before profitability.
Because cash burn is a core metric, it also indicates how well your business can manage its inventory levels and operations. A company with healthy cash flow and no debt obligations is likely doing well.
But a high burn rate doesn’t say too much about a company’s financial health on its own. It might indicate that the company won’t have enough money to continue operations and achieve its business goals. Or it could be part of the company’s strategy to grow and achieve profitability in the short term.
Calculating cash burn shows you how much money your company consumes in a given period. Tracking cash burn can help you identify trends and take corrective action before it’s too late.
The best way to calculate cash burn is to find the difference between your start and ending cash balance. Then, divide the difference by the number of months in the period.
Imagine your starting cash balance on January 1st was $600k, and the ending balance on March 31st is $240k (a difference of $360k).
$600k – $240k = $360k
Divide the $360k difference by three to get your monthly cash burn.
$360k / 3 = $120k
Without unlimited external funding, a business that is constantly burning cash must change its operations or risk going out of business.
Fortunately, there are many things you can do to maintain a healthy cash flow while keeping your business afloat until it reaches profitability.
Collecting customer payments quickly reduces how much cash you’re lending them. If there is a lag between when you invoice clients and when they pay, you will have cash burn problems. Invoices should be sent promptly (and delivered electronically) so that the payment terms clock can start ASAP.
If your cash flow projections show you will run out of money before the end of the month, it’s time to cut expenses. It’s best to cut unnecessary costs that will not negatively impact your business or customers.
Only pay when bills are due. Assuming you’ve negotiated fair credit terms with your suppliers, there’s no reason to pay bills as soon as they come in. This delay helps offset costs, so you’re not paying everything at one time during the month.
If there’s no other option, consider raising more capital from investors. This can be challenging because it increases your risk and dilutes ownership for existing shareholders. However, this option is worth exploring if you’re burning cash quicker than expected.
Conducting a pricing analysis will help you assess your pricing strategy. You might not be generating enough revenue because your prices are too low or too high or low. Figure out the best price point for your business and adjust the pricing accordingly.
Cash burn is a core metric that startups should be carefully tracking. This measure of the amount of cash a company consumes over a given period indicates your business’s financial health.
Because running out of cash will make it hard to stay in business, cash burn is one of the most important financial metrics for any business.
Controlling cash burn and developing strategies to become cash-flow positive are essential aspects of running startups and small businesses. Managing cash flow on your own can be challenging. But the experienced accountants at Founder’s CPA can help you understand your business’s current situation and identify your levers for cash flow improvement.
Contact our experienced accountants to see how you can better manage your startup’s cash burn.
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