How to Effectively Forecast Cash Burn Rate During Growth
If your business is consistently showing positive numbers quarter over quarter, you have something to celebrate. Who wouldn’t be excited about hitting their stride with true company growth? But before you get too focused on all the things you’ll do with your new sales numbers, know that there’s still at least one significant challenge ahead. Get the facts about how your cash burn rate should be estimated, tracked and adjusted to ensure you have the capital to continue growing and thriving in the days ahead.
On the surface, the term is simple: cash burn rate is a popular phrase used to describe how fast you’re going through your money. From there, you can break out the term into gross and net categories. Gross burn rate is usually applicable to startups that may not be generating any revenue yet, so the number accounts for the monthly expenses of the business. Net burn rate, on the other hand, assumes sales and represents monthly costs subtracted from monthly income.
Note that both cases may result in a cash burn that exceeds revenues and will cause available capital to dwindle over time. It’s extremely important to track this number and forecast what it will be in future months so you can line up additional funding (or increase sales) to cover costs.
Calculating Your Magic Number
It’s impossible to know your actual rate of burn without having a few months of data to use as a basis for your trend. Start by gathering data from all cash flow sources, including operating, investing and financing, and then decide what time period you will use as a basis. Many companies choose the last quarter, but if you have a longer history, up to 12 months may be useful.
Gross burn rate can be found by comparing the amount of capital at the beginning of the data period with the cash available at the end. The difference should be divided by the number of months in the data period to get your monthly rate. Net burn rate is calculated in the same manner, but revenue should be applied against the cash spent. So if your costs are $200,000 per month and you have $50,000 per month in revenue then your net burn is equal to $150,000. In both instances, it’s important to factor in only regular cash or cash-equivalent transactions and exclude one-time or non-recurring income and expenses. This could be a big purchase like new equipment that will not need to be replaced for a few years or end-of-year tax preparation fees.
Now that you’ve calculated the number, you can more easily determine future expenses and how long that cash reserve will last. While the rate by itself isn’t necessarily good or bad, what it means for your existing cash reserves is important. Both new and established businesses should use this number to determine their “cash runway,” a term that indicates the amount of time a business could stay in operation, without any additional funding or revenue, given the current revenue generation and expenses.
In plain terms, a company generating $22,000 in monthly revenue that spends $24,000 monthly in expenses will have a cash burn rate of $2,000 per month. If the same company has just $10,000 in cash reserves, they can stay in business for five more months at the current burn rate.
While the rate is a good tool for doomsday scenarios, it’s better used as a commonsense forecasting tool to help prioritize financing campaigns — it makes an excellent countdown timer to let you know how quickly you should start looking for an influx of cash.
It’s also an excellent yardstick for determining if it’s time to reinvest in your business. If your cash burn rate is positive, your cash reserves may grow too large, indicating that it might be time to put some money back into infrastructure, technology, talent or marketing.
Growth is a big success for any business, and the last thing anyone wants is to hinder that growth due to a lack of resources to support the organization. By calculating your cash burn and forecasting your spending, you can ensure that your business continues to be successful.