Do you ever wish you could gaze into a crystal ball and see exactly where your business will be in X amount of time? Predicting the health of your business is a helpful skill in the strongest of economies, let alone during COVID-19 where every business decision can be crucial for survival. While we have yet to get our hands on a magical cash crystal ball, there are a few metrics that every business owner should be aware of when it comes to cash flow, and we’re here to demystify them. Cash burn rate is one of the most important metrics for business owners to understand. The good news is, it’s also one of the simplest financial metrics that can provide big-picture information about your company’s ability to cover expenses.
Current Burn Rate
Current Burn Rate = Cash Balance in Prior Month – Cash Balance in Current Month
The current burn rate tells you how much you typically spend per month and is calculated by subtracting your current month cash balance from your last month’s cash balance. Business owners can use their current burn rate to create a cash forecast that can help analyze whether there is enough cash coming in to meet upcoming expenses. If your beginning cash balance last month was $60,000 and beginning cash balance this month is $50,000, your current burn rate is $10,000. You will need around $10,000 in cash to meet monthly expenses.
Monthly Burn Rate
Monthly Burn Rate = (Cash Balance Beginning of Period – Cash Balance End of Period)/ # of Months in Period
What if you want a longer cash forecast? Maybe you have large quarterly or semi-annual payments that are not captured by cash needs for a typical month. This is where the monthly burn rate comes in. Calculated by dividing the change in your cash balance over a specified period by the number of months in the period, monthly burn rate allows you to get a big-picture view of your cash needs. If your cash balance at the beginning of January is $100,000 and your cash balance at the end of March is $60,000, your total burn rate is $40,000. Divided over the 3-month period, your average expenditure per month is about $13,300. This can help you forecast your cash needs for larger, less frequent expenses like insurance, taxes, etc.
Cash Runway = Cash Balance/Current Burn Rate
If you stopped bringing in cash today, how long could you pay your bills with the cash left in the bank? There’s a good chance that you’ve had to do some sort of cash flow analysis since the start of the COVID-19 pandemic, due to a change in revenue streams. Calculating cash runway can help you determine a baseline “worst case scenario” for your company if you were to stop bringing in cash today. If you have $100,000 in the bank and your current burn rate is $10,000, then you can continue operating for about 10 months without any new cash coming in the door.
How to Reduce Burn Rate
In a perfect business environment, your company would have a negative cash burn rate (i.e. saving more cash than you’re spending). However, that’s not the reality of many businesses in a start-up or growth phase. One of the easiest ways to reduce your burn rate is to be strategic about your payables. In a time where pursuing new or additional revenue may be difficult, it’s the perfect time to evaluate your expenses. Knowing when payments and invoices are actually due and negotiating payment terms with vendors are easy ways to lower burn rate as many banks, landlords, and vendors are offering flexible payment terms due to COVID-19.
How We Can Help
Want to leave the money stuff to us so you can use your time and energy on what makes your business special? We can help you easily create a predictive cash flow model featuring different hypothetical scenarios using our AI modeling technology (okay, maybe we do have a bit of a crystal ball). What if you delayed loan or rent payments? What would happen if you experienced a 50% drop in revenue? We can help you analyze what-if scenarios and take the guesswork out of your cash flow needs. We can also help you identify your largest vendors and trends in cash in- and outflows with our predictive AI technology to make sure you are in a stable financial position in an ever-changing economic environment. Want to learn more? Schedule a conversation with us so we can help you identify opportunities for improved cash flow for your business.