Understanding Cash Burn and How to Effectively Manage It
After the triumph of completing the fundraising phase, startup founders will be facing a new challenge – how to spend it right. One of the most important factors to look out for when it comes to spending is the cash burn rate. The improper way of handling cash can take a toll even on billion dollar startups. So, how do you manage the cash burn rate? Credo will take you on the journey of easily understanding what it is all about and how to handle it.
What is Cash Burn or Burn Rate?
Before anything else, we will delve into what cash burn or burn rate is. As defined, the cash burn rate is a measure of how fast the supply of cash is spent over a period of time.
To make it clearer, let us set an example. If you are a startup that has a monthly expenditure of $10,000, then your burn rate per month is $10,000.
Accordingly, there is what we call “runway”. It is primarily the number of months left before the startup ran out of money and gets out of business.
Let’s say you already raised $100,000 and every month the monthly spending is equal to $10,000, your runway would then be 10 months.
Read here for a better understanding of cash burn rate.
Why is Cash Burn Essential?
The burn rate suggests a startup’s lifespan. If the business is burning cash at a rapid rate, then it is sealing its fate towards bankruptcy.
At times like this, you will need to raise more money. It could come from fundraising, loans, grants, or awards.
The best solution would be the profit you will earn from the startup. If the income keeps on, you can say that you have enough funds for growth and possible crisis that may come along the way.
Failure to keep the cash flow running would mean just one thing: the business will soon be closing.
Once you run out of funds to operate the business, you don’t have a choice but to liquidate the assets to make sure the shareholders will still be compensated.
There are times guarantees are made by the business owner. This, in turn, will make you liable to pay back the creditors coming from your funds.
That is why understanding the burn rate and runway is important. This will remind you of how much money and time is left for the funds to work and try to work out new financing.
If you have a longer runway, you can attracting investors and even lenders to fund the business.
On the other hand, a shorter runway would mean the investors would have the power to request more capital.
At this point, investors may intentionally and constantly remind you of the remaining runway and funds.
A good way to battle this is to make sure you are ahead of every aspect including the timeframe and what should be done.
Common Obstacles to Cash Burn
Some of the factors that hinder a good cash burn rate are as follows:
Managing Cash Burn
While there isn’t a standard burn rate, it is important not to underestimate it. One way how you can manage the cash burn rate is by understanding the following factors:
- How much you are spending
- How much cash you are bringing in
Ways to Lower Your Expenditures
Probably, the easiest way to improve the burn rate is by reducing the overall expenses. It can be difficult to just cut costs instantly so getting advice from a professional is a must. Credo offers CFO services such as financial intelligence for rational decision-making and determining the best use of funds which in turn can help in managing the cash burn rate.
Here are also some of Credo’s takeaways on how to lower the expenses.
Get rid of expenses related to physical space
If there isn’t a high need for a physical office, you can eliminate it instantly. As more and more opt-in working remotely, there is no reason for you to rent or lease office space. So, to help with improving the burn rate, you can start by getting rid of that physical space. If you also have real estate assets, you may want to sell them. The proceeds can then be used as capital to lengthen your runway.
Minimize labor costs
Cutting costs on labor is seriously difficult on the part of the owner much as to the employees. But this can be helpful if you need to improve the burn rate.
Reducing manpower or simply layoffs is the primary solution in cutting labor costs. The cut can be done in the early stage if you foresee that the labor cost is too much. The easiest way to do layoffs is to shift from in-house employees to remote workers. You would benefit more because you don’t have to pay for equipment, insurance, benefits, and workspace. At this time, you also have the chance to combine positions. By combining, we mean one worker can have more than one position. You can pay them more but still get more out of them because they can do multiple tasks.
Lower the Inventory
As much as you want to keep everything in stock, you cannot. Even if you are keeping enough stock just in time for special offerings or holiday discounts to be offered, the burn rate will tell you not to.
It is said that on-hand items are referred to as more of an expense and still a liability until sold. There are also associated holding and insurance costs. Over time, its worth can devalue. So, try not to keep as many on-hand items to avoid the burden of an idle investment.
Revamp your finances
Other than costs in labor, stocks, and physical space, your finances are also expenses of the business. You can cut costs by modifying your loans, refinancing the loans, exchanging the credit card balances for better deals, and getting rid of leases.
Cut your subscriptions
A lot of startups find the need to have all the subscriptions. Well, one is not required to. That is because many corporate and individual consumers nowadays exceeded the limit on subscriptions. Aside from that, there are also instances wherein you no longer use a particular subscription yet you keep on paying for them. Now is the time to do a check on what your subscriptions are and evaluate which ones you should keep and which should be cut.
If there is a subscription you need, try to look for better deals or at least downgrade it.
Look out for affordable services
There is nothing wrong with going for a cheaper option. It’s just a matter of asking. You can inquire if they offer bundled services. Most of the time, the rates are reasonable and will give you better savings compared to seeking individual services. At times, you can figure out that you have overpaid on certain services in the past.
Ways to Improve Cash Flow
Now, that you are successful in diminishing the expenses without affecting so much of the processes, the next step towards successful burn rate management is increasing the cash flow.
Here, we will focus on the discretionary income as well as the profit that is yielded every month. Credo will tackle the abundant ways by which it can be achieved.
Raise your funds
Our first plan to attain sustainability is through raising more money. It is what we can do firsthand. But don’t just bring in money to satisfy the need to. Go with equity capital that won’t require you to pay monthly. But with the new funding comes responsibility as well. You are expected to improve your overall standing financially. If you fail to do so, this may result in a deeper problem which can be a reason to lengthen the time towards what we don’t aim to.
Revamp your unit economics
Unit economics is the business’ income in correspondence to an individual units’ cost of production. At some point, some startups often fail when it comes to unit economics.
It can be because it is too thin or other underlying factors we don’t have control of. Anyhow, there are ways by which you can improve the unit economics. You can start by shortening the sales cycle, optimizing marketing, and improving the overall operations.
Grow your sales
After improving your unit economics, there should be a chance of increasing the sales and reducing the negative cash burn.
If the sale continues, attaining profit and being sustainable can be easily achieved. Aside from the paid advertisements, you may want to invest in affordable methods to pair it up.
One of which can be promotional techniques such as collaboration with other brands and reusing content to make the most out of it.
If you also have leads from the past, you may want to check on it again. You’ll never know, there can be sales that can come out of it. On the other hand, if you are using a paid promotion, you may want to alter some of it. Try to do a little change and it may show positive results on the page view, page visits, and clicks which could yield better sales and leads.
Get more cash upfront
Businesses that have been in the industry can sometimes be used to the traditional way that changing it can be difficult. But, as we say, change is constant in all things, including processes.
It can be a big leap but with the trends today, this change is inevitable. If you’re used to long invoicing times, financing, free trials, now is the time to take a different path.
One change can be getting more cash upfront from your customers. It can be a direct or indirect way of asking for bigger down payments and deposits or simply discounting your customers if they pay in cash.
With this, you’ll have a chance to improve the sales without depriving your customers who cannot afford to shell out more any upfront cash.
Add new premium pricing tiers
At some point in time, startups and even businesses that have been in the industry for a long time have to alter their prices. One of the common mistakes they do is just make the prices higher.
As customers aren’t enticed with the same product at a higher cost, they end up going with another competitor. This should not be the case if pricing tiers are taken into consideration.
Not all of us are knowledgeable about tier pricing. It is a strategy that is presented to customers that shows different levels of pricing. You can maintain the pricing of other items but you can also add a premium pricing tier. This may include an add-on feature that a basic one has but with the addition of just a few bucks in it.
Upselling and Add-ons
Attracting more customers can also be done through added features. Today, businesses can offer variations in their products. They are able to set up bundles that include different stuff a customer needs. Sometimes, they also offer upgrades or add-ons to a particular item. This is what we call upselling. It is a healthy way to add income. As a result, you’ll have good unit economics standing and the ROI is attainable.
Pending income or collections
If you have terms as a payment option, there is a long time of waiting until you earn it. While you cannot control it, one way to ease up the collections is through enticing your customers with a specific benefit. Let’s say they can be discounted once they do early payments or can incur penalties if settled late.
Read here for a more comprehensive discussion on how to have a healthy cash flow and sustained growth. (hyperlink to blog article Sustaining Company Growth Through A Healthy Cash Flow)
Inadequate knowledge on how to manage cash burn can lead to problems and ultimately to the downfall of your startup. Thankfully, there are a lot of ways to improve your cash burn rate, growing one’s profit, and lengthening the runway.
On top of that, sustainability is a must for every startup to survive. This will help in easily managing the burn rate without having to be pressured on raising capital. Accordingly, every bit and piece will fall into place and you’ll never know, you’ll be able to entice more investors.
If you are having difficulty in managing the cash burn rate and other financial aspects of your startup, we got you covered. At Credo, we offer CFO, CPA and exit strategy services. Contact us today and deliver positive results in no time.
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