This problem of Cash burn is a major one in case of businesses, especially in the new businesses, also known as Start-ups. The Cash burn is simply put, as how much cash is put in the business to keep it running. The Cash burn is a major problem, because lot of business revenue is generated only after extensive Marketing and Selling cost. For extensive M&S cost, lots of funds are to be injected from time to time, now M&S channels are very broad and the reach is very wide.
The Cash burn and Cash Runway both the rates are vital for the growth of a business. To monitor it on regular basis is of utmost importance.
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1. What is the Cash burn?
The Cash burn is the rate by which the company is using or consuming cash in the business. It is measure of the usage of the cash consumed on various activities that are important to be conducted.
It is to be continuously observed so that the business activities, dependent on cash are not affected. The Cash burn is important as Cash is the blood for the business.
2. What is the use of Cash Burn?
The crisis can increase if the cash burn is not kept in control and measures to reduce it or to enhance the ways to procure more cash are not increased. More often than not, businesses just starting out aren’t profitable yet, particularly in high-growth technical industries. It may take a few months to a few years to achieve profitability, meaning that you’ll need to keep a close eye on your cash and funding of expenses.
3. What is the Cash burn run rate?
To ascertain the cash burn run rate, the basic document required is Cash flow statement. If the business doesn’t have cash flow statement, it can use its simple cash account or register maintained for the same.
For e.g., Cash opening on 1.1.2022 is 2,00,000 INR and cash closing is 1,40,000 INR on 31.3.2022.
So cash burn = Cash at beginning-Cash at ending
=2,00,000-1,40,000
=60,000
Duration = 3 months
Cash burn rate= Cash burn/Duration
=60,000/3
=20,000 per month.
4. What is Cash runway?
The Cash runway is the measure of Cash usage or consumption at the current cash burn rate. So for example if I have a reserve of cash of Rs. 80,000. I can easily comprehend that the current reserve will last for 4 months.
Cash runway= Cash balance or reserve/Cash burn rate
=Rs.80,000/20,000
=4 months
A negative cash burn ratio is always the best, it means the business has created a reserve, to meet expenses without crisis. In case of bootstrapped start ups the companies must plan the cash budget based on the above ratios.
5. Ways to reduce the expense
To reduce the expenses to meet the cash budget following can be done; the list is inclusive and not exhaustive-
i. Increase Revenue-
Focus on increasing sales is the best way to manage any business crisis. Finding the ways to improve the income streams is the best ways.
ii. Reduce Inventory-
To meet the cash burn rate, it is an important step to reduce inventory. To keep inventory in optimum levels is a good idea. It will help in reduction of wastages, inefficiencies in inventory management. Also it will enhance the procurement process.
iii. Manage expenses-
To meet the cash burn rate, it is important to reduce all the expenses. To manage the expenses in efficient ways it is suggested to make MIS and its timely review.
iv. Cash conversion cycle-
To improve the cash conversion cycle, it would have long term impact. As it would keep debtors and creditors aware of the payment terms of the firm.
v. Debt service management-
To meet the debts, if cash is going out at a faster pace, it is suggested to convert it in Equity so that cash expenses can be reduced.
6. Burn rate brings confidence-
The burn rate should bring confidence in the investors. If the reach of the business has widened and thus the burn rate has shot up, it is a sign of good business strategy, it will give business better valuations.
For investors it is sign of growth and evidence of acceptance in the market. So not necessarily it is important to reduce the cash burn. An increasing trend signifying growth is always a welcome change.
The risk that entrepreneurs run is that they assume they have product-market fit, spend a lot of money, and then find that their analysis was wrong. One can’t become efficient after hypergrowth. So, a start-up needs first to figure out the core business idea to improve on and then scale up.
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