If a company is to remain sustainable, and more importantly, stay in business then it’s vital that it understands its cash burn rate. But what does this crucial metric really mean?
Put simply, your cash burn rate measures how quickly you use up your available cash flow. It’s usually a negative figure, indicating that your cash on hand is dwindling, but in particularly profitable periods some businesses may experience a positive burn rate and build up their cash stocks.
Typically, the burn rate is quoted as a monthly figure, but if your business isn’t on a sustainable footing it’s possible you can burn through your cash in weeks or even days.
Calculating your cash burn rate
Your burn rate is essentially a summation of your operating expenses. You can obtain this figure by adding together everything you spend: rent, business rates, raw materials, consumables, salaries, bills and taxes.
This is a relatively simple step if you have a cash flow statement on hand. If you don’t, here’s how to prepare one.
There are two ways to do this, using either accrual or cash accounting. Most large companies use the accrual method, though this is less meaningful in illustrating your real level of cash on hand.
Using the accrual method, the win of a major contract would immediately be recognised as revenue, even though you may not receive the money for quite some time.
The cash accounting method is therefore a much better way for a small business to prepare its cash flow statement. A statement could appear as follows:
Cash received from customers
Cash paid out (to suppliers and employees)
gives your cash generated from operations.
Any interest and taxes paid
to give your net cash flow (either positive or negative) from operational activities.
Then consider cash to or from investment activity:
Proceeds from any sales of assets
Any dividends received
to give your cash generated from investment.
Any dividends paid out
Any cash used to fund investment
to give your net cash flow (either positive or negative) from investment activities.
Finally, simply take your opening cash position and factor in your net cash flows for both operations and investment to understand your probable financial position on any given date.
By projecting these figures over months or years (and remember to be realistic – don’t assume that you will keep customers forever or that your present rate of growth will necessarily be sustained), you can project your cash burn rate. This can be expressed as the following formula:
Gross Burn Rate = Cash/Monthly Operating Expenses
Meanwhile, your net burn rate calculates how quickly you are losing money. To calculate this figure, first subtract your monthly operating expenses from your monthly cash income, then create the following formula:
Net Burn Rate = Cash/Monthly Operating Profits or Losses
A high burn rate indicates that you don’t have long to go until your cash reserves hit the red, at which point you will no longer be able to meet your financial obligations unless you take out a small business loan. So how can you reduce a rapid burn rate?
Reducing your burn rate
There are several ways to reduce your burn rate – some positive and some more negative. Let’s start with the most positive.
Grow the business
Improving your burn rate isn’t simply about trimming costs: it’s also important to consider the other side of the equation. If you can increase your monthly revenues whilst increasing your monthly outgoings at a lower rate, then your burn rate will improve.
Invest in marketing
To take the business to the next level, you may need to invest in a marketing campaign.
This might seem counterproductive: in the short-term you will be spending more each month, meaning your gross and net burn rates will get worse. But if your marketing pays off in terms of profitable business gains, the long-term picture will be immeasurably improved.
Manage your expenditure
If there are no obvious signs of imminent business growth, then you will need to look at cutting costs. Some changes are relatively simple: you may find that your fixed-line telephone, mobile and broadband packages can be consolidated or moved to a different supplier with more favourable tariffs.
Similarly, if your premises offer more space than you are using, you could consider relocating to smaller premises with a reduced rent.
Get paid faster
When it comes to cash flow, it’s not just a question of what you get paid but when. Cash sales, of course, are king – you get the money in your hand straight away. But if you’re in a business-to-business sector, then you’ll almost certainly be invoicing in advance and awaiting payment.
Don’t let your customers take forever. If you’re offering 30-day terms, then start chasing for payment the instant the deadline is up. Another option is to use the carrot-and-stick approach. You could offer a small discount for payment within a week and levy interest at statutory rates for late payments.
The converse is to pay your suppliers more slowly. Many suppliers would be prepared to agree longer payment deadlines (say, 60 or 45 days rather than 30) in order to keep your business. Once again: when you pay matters, not just what you pay.
Reduce the cost of raw materials
If you’re operating a manufacturing business, raw materials will make up a substantial proportion of your costs. Be prepared to shop around to get the best deals, and don’t be afraid to negotiate aggressively with your suppliers. This could mean the difference between success and failure for your business.
If all else fails, look at redundancies or pay cuts
Redundancies should obviously be a measure of final resort, not just because of the humanitarian aspects but because depleting your team reduces your capability to take on profitable new business.
But if you’re struggling to pay your staff, and particularly if you have people who are under-utilised, then this is certainly an option to consider. An alternative would be an across-the-board pay cut of, say, 5% or 10% until the business climate has improved.
So, what happens if your cash burn rate remains unfavourable?
If you’ve tried all the above and your cash burn rate remains stubbornly negative, you should talk to Cashsolv.
We’re the specialists in small business finance, and we’ll find the solutions to keep you trading. Invoice factoring and discounting could tame a troublesome cash flow forever, by allowing you to borrow against the value of your invoices as soon as you issue them so it’s like making a cash sale.
Alternatively, if you’ve hit the wall and you have bills you simply can’t pay, we offer emergency loans where we can have funds in your account in under 24 hours.
To discover what we can do for you, get in touch to discuss your circumstances.