Traditionally, a cash burn rate was something that mattered only to VC-funded startups. But the global pandemic has made it a relevant metric for companies in every growth stage. At its core, cash burn is about expenses, specifically fixed ones—those line items that don’t go away as your business adds – or loses – revenue.
“No matter what stage a business is in, there’s a cost structure that is minimum to operate the business,” says Josh Farber, XMI’s chief financial officer.
For startups that lose money every month, understanding those expenses is key because it signals when the company needs to raise more funds. In a growing or mature business, Farber says it’s important to know fixed costs so you can understand your relationship between income and expenses.
“If your company has 100 clients and you need at least 60 to cover fixed costs, that’s an important number to have in mind, especially during uncertain times,” he says.
Calculating your company’s cash burn rate is relatively simple if you’re already generating monthly profit and loss statements.
Farber recommends choosing a recent P&L statement from a stable month, and going line by line to figure out which expenses stay the same no matter what happens with revenue (fixed costs) and which fluctuate as you add or lose customers (variable costs).
Examples of fixed costs: Rent, loan payments, insurance, leadership team salaries, utilities
Examples of variable costs: Raw materials, sales commissions, direct labor costs
Once you separate the two, add up the fixed costs and decide how much revenue you need to generate each month to cover them. The next step is contingency planning. “This is where you prepare for the worst, while hoping and planning for the best,” Farber says. “In other words, if things go bad, which of these expenses can be cut and in what order?”
The expenses and sequencing of cutting them will largely depend on your business and the type of work you do. Low-hanging fruit include halting corporate travel, putting a temporary freeze on a 401(k) match and eliminating certain employee perks. If breaking a lease isn’t an option, maybe finding a sub-tenant is. This list of ways to recoup cash flow from Bill.com is also a good place to start. It recommends negotiating around your accounts payable, checking in with lenders on financing options, selling idle equipment and doubling down on outstanding invoices.
Understanding your expenses isn’t just for when there’s uncertainty. Farber recommends this as an annual exercise, performed alongside the annual budgeting process. “There is a delicate balance when investing in your business,” he says. “Do you build the infrastructure you need to support anticipated growth, or do you prove it first and manage through some pain while you attach the wings when the plane is in flight?” Regardless of your approach, the first step to sound strategic planning is knowing your baselines.
Discover more accounting best practices like these by downloading our new ebook, the XMI Guide to Best Practices in Small Business Accounting.