Peaks and valleys are the norm in business. A big part of whether your company has staying power is whether you can survive those tougher times when your cash inflows plateau. Understanding your cash burn rate is an essential piece of making it through.
Once you know your company’s burn rate, you can manage your cash flow more effectively. At ForwardAI, we’re strong believers that the more you know (cue the shooting star), the better you can position your business for growth and stability.
Table of Contents
- 1 What’s a business’s burn rate?
- 2 Calculating your burn rate and runway
- 3 4 ways to manage your cash burn rate
What’s a business’s burn rate?
Your burn rate is the amount of money you spend to keep your company going during a given period. (Burn rate is almost always measured monthly.) You can also think of it as your monthly net-negative cash flow.
Although you might often hear references to burn rate or cash burn in the context of startups, this metric is just as useful (and important) for businesses that have been around for years.
Startups pay extremely close attention to burn rate because:
- Many of these businesses take several years to be profitable. That means that they have to be extremely diligent about how quickly they’re burning through the money in the bank because the company’s gross cash burn is the same as its net cash burn. (In other words, there’s no money coming in to offset any gross operating expenses.)
- Burn rate is a metric that investors care a lot about. They want to know how far their existing funding will go — and how far the money they’re raising will go, too.
But these things are relevant to your mature business, too.
Why you should care about your burn rate: runway
The above is a really just a fancy way to get at understanding a business’ “runway.” And that’s important for every company. You want to know how long your company can last if you never make a cent again. (Don’t worry, you will! We’re just giving you the facts so you can hedge against worst-case scenarios.)
Runway is how long your business will be able to stay open at that current burn rate. That’s why every small- and medium-sized business needs to care about burn rate and runway
Calculating your burn rate and runway
Luckily, this important metric isn’t too hard to figure out. We’ll calculate the monthly burn rate.
- Step 1: Pick a period on your cash flow statement. Find the starting point of your cash balance, then locate the ending point for the period.
- Step 2: Subtract the starting point from the endpoint. Then, divide the difference by the number of months in the period you’ve chosen.
- Step 3: Access your bank balance. Divide your balance by the burn rate. Your product is your minimum runway, based on your cash burn. (Note that this number assumes stable net cash burn, aka you don’t bring in any additional revenue).
An example of calculating burn rate
Let’s say we’re examining the first quarter of the year. Your cash position at the beginning of January was $100,000 and at the end of March, you finished up at $70,000. Right now, April 1, you have $280,000 in the bank.
Calculating monthly burn rate:
$100,000 (starting balance)- $70,000 (finishing balance) = $30,000
$30,000 / 3 (months) = $10,000
Monthly burn rate = $10,000
Calculating remaining runway:
$280,000 (cash in the bank) / $10,000 (monthly burn rate) = 28
Remaining runway = 28 months
4 ways to manage your cash burn rate
You might find it a bit scary to see your business’s lifetime reduced down to a number of months. And, hey! With good reason. If you’re operating in the red, running with an end in sight can feel like receiving a terminal diagnosis if you’re running on reserves.
But it’s much better to know what’s wrong so you have the opportunity to fix it before it’s too late.
1. Cut your expenses
As you might expect, the easiest and most straightforward way to bring down your burn rate and add time to your runway is to spend less. Consider auditing your operating costs before anything:
- Is there anything you can do to bring your monthly fixed costs down since those are the big, recurring expenses that cut into your runway?
- Are you able to refinance any existing debts?
- If your operating margins are extremely thin, are you spending on the right things? Did you try to kick into a period of high growth before you were ready?
- Are you running as lean as possible?
- Is there a way to get your costs of goods and services (COGS)down? Can you renegotiate contracts with suppliers, or swap out elements of your manufacturing with different, lower-cost materials?
There are a lot of questions you can ask of your business. Now’s the time to ask them.
2. Generate more revenue
If cutting your costs isn’t or won’t be possible, you might want to explore the possibility of earning more money for your business. Note: Opening new revenue streams often requires significant investment.
That said, you might be able to make smaller tweaks to existing systems to either tap into or build upon recurring revenue. Consider some of the following questions:
- Is your business model a fit for any sort of subscription- or retainer-based services?
- Can you offer an upgraded tier of service for an increased fee?
- Do you have any unsold inventory that you can get rid of for cheap? (Cheap is better than unsold, and the cost is already sunk, remember.)
3. Raise funds or apply for financing
You have a couple of options here.
First, if you haven’t taken on investors before, maybe now would be a good time to consider them. Investors aren’t for every small business, but if you want to infuse capital into your business to give yourself more runway, you might look into raising money.
Second, and perhaps more practical for most small businesses, is to look into business funding. You can apply for several different types of financing to buffer your cash reserves, including business line of credit and term loans. Both of these traditional options are a great place to start.
4. Control your cash flow
Above all, controlling your cash flow is the best way to manage your burn rate without dramatically altering anything. There are a few ways you can do this operationally:
- Can you collect on your outstanding invoices more quickly?
- Evaluate your current trade credit relationships. Can you incentivize your customers to pay in cash more, and more often?
- Can you pay your own invoices slower, or negotiate (or renegotiate) your own trade credit terms?
- Do you need to take advantage of invoice factoring to free up unpaid or not-yet-due invoices?
- Can you incentivize monthly customers to prepay yearly fees in full?
The second part of managing your burn rate is taking advantage of all of the financial data you have. ForwardAI’s insights and analysis, which contain a cash flow forecast and business risk score, help you fill in vital pieces of your financial puzzle.
By integrating directly with your accounting software, your insights and analysis from ForwardAI will automatically reflect the most current data in your system. (Once connected, ForwardAI checks for updates daily.)
The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.
Image via Pexels.