Like cash flow, a company’s cash burn rate is an indicator of a business’s financial health. Whether you’re just launching your small business or thinking about growing your existing business, it’s important to understand the cash burn rate definition and how it affects your business.
What Is Cash Burn Rate?
Cash Burn Rate Meaning: The rate at which a business uses its cash reserves.
Simply put, a company's cash burn rate is a measurement of its negative cash flow. This figure is typically calculated as a monthly rate. For example, if your business has a monthly cash burn rate of $50,000, it means your business spends $50,000 in any given month.
When cash use increases because of a crisis or slow period, cash burn rate may be calculated on a weekly or daily basis to closely monitor the health of the business.
Why Is Cash Burn Rate Important for Your Business?
Your cash burn rate tells you how quickly you’re using your cash reserves. It’s an important indicator of the financial health of your business.
Cash burn rates tell you:
- Whether your current operations are sustainable
- When you’ll run out of cash
- Whether your cash is moving in a positive direction
- Whether you’re building up a healthy reserve of cash
If a business burns through its cash too quickly, it risks running out of money and going under. On the other hand, if a business is burning its cash too slowly, this could be a sign of stagnation or poor investment in growth.
Cash burn rate is especially important for new businesses or those in the early stages of expansion. But it’s also an essential metric for stakeholders.
If a company is seeking additional capital, investors can use their cash burn rate to indicate whether it’s a wise investment.
When businesses continue to operate on a negative cash burn rate, this is a sign that it’s running on borrowed funds or stakeholder equity.
How To Calculate and Forecast Your Cash Burn Rate for Your Company?
You understand the importance of cash burn rate, but how do you calculate it? The process is a lot simpler than you think.
Here’s how to calculate cash burn rate for a company.
Cash Flow Burn Rate Formula
First, you’ll need to pull up your cash flow statement to see your cash at the start of the previous month and end of the current month.
Once you have these figures, you can use the following formula to calculate your cash burn rate:
- Cash Balance in the Previous Month – Cash Balance in the Current Month = Cash Burn Rate
To find out your cash burn rate for a given period of time, use the following formula:
- Cash Balance at the Start of the Period – Cash Balance at the End of the Period / Months in the Period = Cash Burn Rate
To find out when your business will run out of cash, use the following formula:
- Cash Reserves / Burn Rate
Cash Burn Rate Benchmarks
It’s important to set benchmarks for your cash burn rate and track them to ensure you’re reaching your goals.
For example, if your cash burn rate is in the positive, this is a sign that your expenses are outpacing your revenue and you may run out of cash soon. On the other hand, negative cash burn rate metrics indicate that you’re building your cash reserves.
Cash Burn Rate Example
Let’s put the above-mentioned formula into action and look at an example of cash burn rate:
Cash Burn Rate Analysis
Conducting a cash burn rate analysis is important for every business and can be used for many purposes to improve the financial health and sustainability of a business.
Creating a cash flow burn rate spreadsheet can help you analyze and track your cash burn rate. Ideally, businesses should aim to have enough cash for 18-24 months.
A thorough cash burn analysis can tell you:
Net Burn Rate
Calculating your net burn rate will show the rate at which your company is losing money. It gives you an idea of how much cash you need to continue operating over a period of time.
You’ll need to subtract your operating expenses from your revenue to calculate this figure.
Gross Burn Rate
A company’s gross burn rate refers to its operating expenses. It provides some insight into whether your business is efficient and its cost drivers.
To calculate this figure, you’ll need to add up all of your operating expenses (salaries, rent, other overhead). Next, you’ll divide your cash by your operating expenses to get your gross burn rate.
An accurate cash burn rate analysis starts with an accurate and updated cash flow statement. If you’re not tracking your cash flow, you won’t be able to calculate or track your cash burn rate.
How Much Revenue Your Business Needs
If your business isn’t generating more money than it is spending, you won’t be in business for long. A burn rate analysis will help you gauge how much revenue you need.
Ideally, you should aim for 12+ months of runaway.
Where to Cut Spending
Of course, a burn rate analysis can also help you identify where you need to cut spending. Maybe you can negotiate more favorable lease terms or renegotiate rates with vendors. Marketing and branding budgets may also need to be reduced to keep more cash in the bank.
High Or Low Cash Burn Rate
Is your cash burn rate high or low? What does it mean for your business?
What Does a High Cash Burn Rate Mean?
A high cash burn rate generally indicates that your business is spending money quicker than it’s bringing money in.
If you’re burning through cash too quickly, you may run out of money and go out of business.
What Does a Low Cash Burn Rate Mean?
A low cash burn rate indicates that your business is going through its cash reserves more slowly. Generally, that’s a positive sign, but having a low cash burn rate isn’t always a good thing.
A low burn rate may indicate that your business isn’t investing in growth.
How Do You Reduce Your Cash Burn Rate?
A high burn rate is bad for business. So, how do you reduce it? Here are some tips:
Reduce Expenses
The first and most obvious way to reduce your cash burn rate is to reduce your expenses. Cutting your overhead will immediately improve your cash burn rate.
Target expenses that aren’t directly increasing revenue. For example, can you negotiate lower rent? Maybe it’s time to relocate somewhere less costly.
Other ways to reduce expenses can include:
- Minimizing your inventory of raw materials and other direct costs. Don’t tie up your cash in inventory.
- Reducing payroll expenses by deferring your hiring plans.
Narrow Product or Service Offerings
Take a closer look at the products and/or services that you offer. Which of these revenue streams is unprofitable? Are you spreading yourself too thin by offering too many things?
Narrow your product and service offerings to stay focused on your core competencies. Doing so will immediately improve your cash burn rate.
Increase Your Revenue
Now that you’ve narrowed your product and service offerings, look at ways to increase revenue.
- How can you increase lead generation and nurture those leads?
- How can you improve your conversion or close rates?
- What can you do to increase traffic to your website?
- Do you need to raise your prices?
Higher sales and/or prices can increase revenue and offset your current burn rate.
Keep Clients Around
Even if your revenue stays the same, a high client or customer churn rate can push your burn rate higher. Happy, loyal customers will continue spending money at your business, so it’s worth taking proactive measures to keep them around.
Focus on client retention to reduce customer acquisition costs and leave more money in your bank account.
Send Invoices Immediately
It doesn’t matter how many sales you close. If the money isn’t landing in your bank account, those sales aren’t doing much to improve your burn rates.
Don’t wait to invoice clients or customers. Bill them immediately. The quicker you send out invoices, the quicker you’ll get paid.
Pay Bills Slowly
Improving your burn rate means keeping as much as possible on hand for as long as possible. Paying your bills on their due date or the day before will free up cash in your reserves.
Don’t be delinquent with your payments, but try to delay them as much as possible.
Keep An Eye on Your Cash Flow with Cash Flow Frog
To get control of your cash burn rate, you need to keep an eye on your cash flow. Cash Flow Frog can help.
With Cash Flow Frog, you can create cash flow statements, forecasts and projections quickly and easily. You’ll need this information to calculate your burn rate and monitor your company's financial health.
Plus, Cash Flow Frog allows you to:
- Create and share branded reports for stakeholders
- Create scenarios to see how decisions will affect your cash flow and burn rate
- See which customers aren’t paying on time, so you can take action and get paid faster
- Compare your planned and actual cash flow to ensure you're on the right track to reaching your goals
Best of all, you can do all of this right online and automatically. Cash Flow Frog makes cash flow planning easy, and that makes it easier to take control of your burn rate, too.
Related posts:
You may be interested:
New:
