When you hear the words “burn rate,” you most likely think of startups that are just getting off the ground and relying on venture capital for their funding. While burn rate is something brand-new companies need to be concerned with, it’s not something that established businesses can afford to overlook either.
If you’ve been in business for awhile and you’re ready to grow, here’s what you need to know about burn rate and how to manage it more effectively.
Burn rate defined
In the simplest terms, burn rate is a measure of how quickly your business is using up its cash reserves. That could mean money that you’ve drawn from your own savings, funds you’ve borrowed from friends and family, loans and lines of credit or money you’ve raised through a crowdfunding platform.
Calculating burn rate is fairly simple. You subtract your monthly business revenues from the amount of cash you’re spending. For example, let’s say your small business has a $10,000 monthly cash outflow but it’s bringing in $8,000 in revenue. Your net burn rate is $2,000. If you have $20,000 in cash reserves, you’d be able to continue normal business operations for 10 months.
Why burn rate is important for growing businesses
When you’re a self-funded business, managing burn rate is vital because it influences the pace at which you’ll be able to expand. It’s a good way to gauge how much liquidity your business has and how long you’ll be able to keep the doors open without having to seek out additional sources of working capital.
A lower burn rate is generally considered optimal. A negative burn rate means you’re able to add to your cash holdings month over month. From a growth perspective, it’s helpful to look at burn rate in the context of where the money’s going. A higher burn rate in the short term can translate to more profitability, depending on how the money’s being used.
For instance, if you’re drawing on your reserves to cover the cost of hiring of new employees, making a major equipment purchase or expanding your business location, a temporarily higher burn rate may be justified by the return on investment (ROI).
How to manage burn rate effectively
Keeping your cash flow on an even keel is something of a balancing act, particularly when growth is part of your long game. With that being said, here are a few pointers that can help you keep your burn rate in check.
A straightforward but effective way to slash burn rate is to eliminate unnecessary spending. One way to do that is by rethinking the way you utilize your resources. For instance, if a key piece of equipment breaks, ask yourself whether it’s more cost-effective to replace it or repair it. Cut down on paper waste by going digital with documents as often as possible. Making simple changes can be a boon for your burn rate over time.
Refine your invoicing system.
Another way to avoid gaps in your cash flow is to have a clearly defined invoicing process. Allowing clients to wait 60, 90 or 120 days to pay isn’t feasible when you’re trying to grow. Be selective about who you extend credit to and -depending on the type of business you are running – encourage customers to pay in cash whenever possible.
Refinance debts if you have them.
If you’ve taken on small business loans to fuel your growth, refinancing them could help with minimizing burn rate if it results in a lower monthly payment. Just be sure to calculate how much refinancing costs in terms of the interest and fees to make sure it’s worth it.
Focus on boosting revenue.
Increasing sales is another smart way to curb cash burn rate problems. If you’re not netting the sales numbers you’d like, take some time to rework your sales strategy and processes. Expanding profitable services or product lines while ditching ones that aren’t making as much money could be one option. Revamping your marketing campaign is another. If demand for what you’re selling is steady, raising your prices could result in the higher revenues needed to take your business to the next level.
Strategic Funding provides needed operating funds to small businesses. Strategic Funding has helped businesses in hundreds of industries. Industries served include: restaurants, personal services, construction, medical, manufacturing, agriculture, retail stores, automotive, and food stores.