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.
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.
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:
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.
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.
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:
To find out your cash burn rate for a given period of time, use the following formula:
To find out when your business will run out of cash, use the following formula:
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.
Let’s put the above-mentioned formula into action and look at an example of cash burn rate:
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:
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.
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.
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.
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.
Is your cash burn rate high or low? What does it mean for your business?
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.
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.
A high burn rate is bad for business. So, how do you reduce it? Here are some tips:
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:
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.
Now that you’ve narrowed your product and service offerings, look at ways to increase revenue.
Higher sales and/or prices can increase revenue and offset your current burn rate.
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.
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.
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.
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:
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.
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