Don't be afraid of using up your cash - control your cash burn!
How long can your company last on its cash reserves before closing down? The concept of cash burn is designed to answer this question.
But while this anglicism is commonly associated with the world of start-ups, in reality any organisation can benefit from mastering this concept, particularly in the start-up phase.
So what is cash burn, and why is it important to monitor and calculate it? Are there any tips for reducing it?
We tell you all about it.
Definition of cash burn
What is cash burn?
Cash burn, or cash burn rate, is defined as an indicator corresponding to the cash spent by a company to cover its various costs, even though it is not yet generating positive cash flow.
This is therefore a negative cash flow, relating to the sums required to offset losses.
That's why the notion of cash burn is often associated with the world of startups: sometimes several years pass before young start-ups become profitable.
💡 Does the idea of burning cash in this way seem counter-intuitive to the health of your business? Yet some giants have subsisted in this way before becoming profitable. In fact, there are many examples of start-ups, or even unicorns, that have still not reached the break-even point, such as Uber to name but one.
Cash burn translation
Are you averse to Anglicisms? The notion of cash burn is also found under the following French names:
- Capital erosion,
- Consumption of cash.
Why measure and control your cash burn rate?
Controlling your cash burn remains one of the best ways of anticipating your future cash flows, with a view to :
- make the best strategic and economic decisions
- deal more effectively with unforeseen events and crises.
And this at various stages in the life of your company, whether a start-up or not.
At the start of the business: when should I become profitable?
Even with the best will in the world, it's very likely that your business won't generate money straight away. And this can take longer in certain sectors, such as tech (research and development time, traffic acquisition, etc.).
By controlling your cash burn, you can keep an eye on your future expenses in order to :
- determine how long you will last before profit generation becomes unavoidable for your survival;
- consider whether or not to (re) raise funds;
- make informed investment decisions.
☝️ Your investors are interested in the burn rate! We advise you to take this into account when drawing up your business plan.
💡 O ur advice: consider different scenarios, both optimistic and pessimistic, so that you can anticipate all possible scenarios and not be overwhelmed by events. Also, lay your cards on the table with your investors, demonstrating transparency and honesty. In other words, you will gain their trust more if you achieve your stated objectives, however modest, than if you are surprised by a much larger cash burn than expected.
In a period of growth: how should I invest?
Throughout the life of your company, and particularly during the growth phase, you need to invest to raise the profile of your products or services.
What is the purpose of a cash burn?
Controlling the erosion of your capital means controlling your investment capacity:
- What projects are essential to achieving my growth objectives?
- When can they be completed?
- Are the planned investments too large and will they jeopardise my company's financial health?
☝️ Ultimately, the burn rate is an excellent indicator for finding a balance point and adopting the best strategy.
In times of crisis: how can I make savings?
Crises such as Covid-19 demonstrate one thing to entrepreneurs: they can't anticipate and control everything.
In such a context, determining the burn rate does two things:
- assess your organisation's survival time, so that you can look to the future more calmly and avoid making hasty decisions;
- gain a clearer picture of your cash position, so that you can pinpoint the areas where you need to make savings in order to survive longer.
How do you calculate cash burn?
Calculating the gross burn rate
Let's start by calculating the gross burn rate.
👉 This is the sum of operating expenses incurred by the company, for the needs of its business, over a given period (usually one month).
These sums are of various kinds, including :
- payroll costs
- rent and energy costs,
- the purchase of goods and raw materials,
- marketing and communication,
- loan repayments, interest,
- tax,
- purchase of computer hardware and software, etc.
Calculating cash burn
Once these figures have been compiled, the cash burn calculation is very simple.
It involves subtracting operating expenses from all the revenue generated over the period in question.
👉 Example: a company generates profits of €10,000 per month, but its operating expenses amount to €15,000. Its burn rate is therefore €5,000.
In short, the cash burn is the sum of all negative cash flows.
💡 Make it easier to calculate your cash burn by using a dedicated tool. A few examples:
- Fygr: this cash management and forecasting software for VSEs and SMEs connects securely to your bank accounts and retrieves data in real time. You can then automate and customise your cash flow forecasts to simplify the calculation of your burn rate. You can even create several scenarios.
- Iziago: the cash management solution for SMEs offers a cash flow module. It centralises all your cash flow data and updates it in real time (automatic retrieval of account statements). This makes it much easier to calculate your cash burn and all your forecasts. All with the help of a simple, graphical tool available at an attractive price.
How can you reduce cash burn?
Even though cash burn is a fact of life for entrepreneurs, and one that seems hard to avoid (especially at start-up), it is possible to reduce costs! That way, you have more room for manoeuvre to plan more profitable investments and/or deal with the crisis.
Here are a few tips to help you do just that.
Tip 1: Identify and analyse all your expenditure items
To be better prepared for the future, you need to identify and analyse precisely what you spend on each item.
In this way, you can determine :
- the costs that can be reduced, without impacting on the smooth running of the business and its ambitions for growth,
- which expenses you cannot compromise on, because they are essential to your development.
☝️ Stay as close to reality as possible and carry out a quality audit. Too much optimism... and you run the risk of being taken by surprise!
Tip 2: Save money!
Once you have a clearer picture of your expenditure items, you can determine :
- where to make budget cuts without losing value for your company,
- how to avoid wasting unnecessary money in general.
This culture of cost control, a source of reduced cash burn, involves a number of actions. Here are a few things to consider:
- controlling your stock management to avoid unnecessary costs linked to over-stocking or over-frequent ordering;
- optimise your supplier relations and negotiate your contracts (competitive tendering, better selection of service providers, etc.);
- keep better track of your customer invoices to reduce unpaid bills, which are detrimental to your cash flow;
- concentrate on your core business and not exhaust human and financial resources on side projects that bring little return, etc.
And there are many more examples. It's up to each organisation to determine the best levers to activate to improve its cash flow, depending on its specific circumstances.
Tip 3: Use the right tools
Finally, controlling and reducing cash burn goes hand in hand with using the right tools. Doing things the old-fashioned way, using an Excel spreadsheet for example, soon has its limitations: it's difficult to keep accurate track of all the data in real time and the cash flow.
With cash management software, you can monitor your expenses at a glance and obtain up-to-date, reliable and relevant data so you can make informed decisions.
And what are your secrets for better controlling your cash flow and reducing your cash burn? Don't hesitate to share your tips in the comments!
Article translated from French