Don't be afraid of using up your cash flow - control your cash burn!
How long can your company last on its cash reserves before going out of business? This is the question behind the concept of cash burn.
But while this Anglicism is commonly associated with the world of start-ups, in reality every organization benefits from mastering this concept, particularly in the start-up phase.
So what is cash burn, and why is it important to control 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 the amount of cash a company spends to cover its various costs, even though it is not yet generating positive cash flow.
This is a negative cash flow, relating to the sums required to offset losses.
This is why the notion of cash burn is often associated with the world of startups: sometimes, several years pass before startups 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 startups, even unicorns, that still haven't broken even, like 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,
- Cash consumption.
Why measure and control your cash burn rate?
Controlling your cash burn rate is one of the best ways of anticipating 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 start-up or not.
Start-up: when do I need to be profitable?
Even with the best will in the world, it's highly likely that your business won't generate money straight away. And this can take longer in certain sectors, such as tech (research & development time, traffic acquisition, etc.).
By controlling your cash burn, you can keep an eye on future expenses:
- determine how long you'll last before profit generation becomes unavoidable for your survival;
- consider whether or not to (re) raise capital;
- make informed investment decisions.
☝️ Your investors are interested in your burn rate! We advise you to take this into account when drawing up your business plan.
💡 O ur advice: consider different scenarios, optimistic and pessimistic, to anticipate all possible scenarios and avoid being overwhelmed by events. Also, lay your cards on the table with your investors, demonstrating transparency and honesty. In other words, you're more likely to win their trust if you achieve your stated objectives, however modest, than if you're surprised by a much larger cash burn than expected.
In times of growth: how should I invest?
Throughout the life of your company, and particularly in the growth phase, you need to invest to raise the profile of your products and services.
What's the point of a cash burn?
Controlling the erosion of your capital means controlling your investment capacity:
- Which projects are essential to achieving my growth objectives?
- When can they be carried out?
- Are the planned investments too large and will they jeopardize my company's financial health?
☝️ In the final analysis, the burn rate is an excellent indicator for finding a balance 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 organization's survival time, so that you can face the future with greater serenity and avoid making hasty decisions;
- gain a clearer picture of your cash position, so you can pinpoint the areas where you need to make savings in order to last longer.
How to calculate cash burn?
Calculating the gross burn rate
Let's start by calculating the gross burn rate.
👉 It corresponds to 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,
- rent and energy costs,
- purchase of goods and raw materials,
- marketing and communication,
- loan repayments, interest,
- taxes,
- purchase of hardware and software, etc.
Calculating cash burn
Once these figures have been compiled, calculating cash burn is straightforward.
It consists of subtracting operating expenses from total revenues generated over the period in question.
👉 Example: a company generates profits of 10,000 euros per month, but its operating expenses amount to 15,000 euros. Its burn rate is therefore 5,000 euros.
In short, cash burn is the sum of all negative cash flows.
💡 Make it easy 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. It then automates and customizes your cash flow forecasts, simplifying the calculation of your burn rate. You can even create several scenarios.
- Iziago: the cash management solution for SMEs offers a cash management module. It centralizes and updates all your cash flow data in real time (automatic retrieval of account statements). This greatly simplifies the calculation of your cash burn and all your forecasts. All with the help of a simple, graphical and affordable tool.
How to 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'll have more room for manoeuvre to plan more profitable investments and/or cope with the crisis.
Here are a few tips.
Tip 1: Identify and analyze all your cost items
To better face the future, you need to identify and analyze exactly what you spend on what.
In this way, you can determine :
- which expenses can be reduced, without impacting on the smooth running of the company and its growth ambitions,
- expenses you can't compromise on, as 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 money in general.
This culture of cost control, a source of cash burn reduction, involves a number of actions. Here are a few avenues to consider:
- control your inventory management to avoid unnecessary costs linked to over-stocking or over-frequent ordering;
- optimize your supplier relations and negotiate your contracts (competitive bidding, better selection of service providers, etc.);
- monitor your customer invoices more effectively to reduce unpaid invoices, which are detrimental to your cash flow;
- focus on your core business, rather than exhausting human and financial resources on ancillary projects with low returns, and so on.
And the examples are numerous. It's up to each organization to determine the best levers to activate to improve its cash flow, according to its specific needs.
Tip 3: Use the right tools
Finally, controlling and reducing cash burn goes hand in hand with using the right tools. A traditional approach, using an Excel spreadsheet for example, soon has its limitations: it's hard to keep track of all the data and cash flow in real time.
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 to better control your cash flow and reduce your cash burn? Don't hesitate to share your tips in the comments!
Article translated from French