Having cash to burn is every entrepreneur’s dream. But what is your current cash burn rate and how does it affect the sustainability of your business? If you have a negative cash flow for too long your business can be in jeopardy and you may risk having to file for bankruptcy. How can you manage you cash burn rate?
Your cash burn rate is the rate at which you are losing cash in your business. It is a metric which is important to an investor as they will look at this rate before investing in your business or if they have already invested in your business this rate will become important for them to know how well their investment is doing and if they need to jump in and rescue it.
You calculate your cash burn rate as follows:
STEP 1: Establish the period you want to use to calculate your cash burn rate over.
STEP 2: Work out the starting cash amount of the period and the cash amount at the end of the period.
STEP 3: Use the following equation to work out your cash burn rate:
Cash burn rate = (starting cash amount – ending cash amount)/months in the period
For example:
Cash burn rate = (R20 000 – R1100)/3
Cash burn rate = R3000 per month
When we have this rate we can work out how much longer the company has before it will use up all its cash reserves. This amount is known as the cash runway. The calculation is as follows:
Cash runway = current cash balance/cash burn rate
Cash runway = R11000/3000
Cash runway = 3.6 months
With the current calculation we can deduce that should the company continue to lose money at the current rate, it will only have three more months. So something will need to be done to ensure the business stays a float. What can do if your cash burn rate is a threat to your business?
- Reassess your expenses: It is important to be aware what you are spending money on and if you have subscriptions which are not beneficial to your business anymore you should cancel them.
- Save money: When you do have bumper months it is important to put some of the cash away for rainy days. This will ensure that your company will remain afloat during dry patches.
- Collect outstanding payments. Do you have a lot of outstanding payments? It is important that your daily sales outstanding is kept to a minimum. If your terms are 30 days and you are consistently receiving payments 10 days later than that then it is time to review your collections policy.
- Sell office assets. You may not have many assets as an SME but it is important to sell those assets which are not bringing in revenue. Have a look around your office and sell those items which do not add to your bottom line.
By assessing your cash burn rate periodically, you can make sure your business is on the right track and keep from being caught unawares should your business be on shaky ground.
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