Startup companies often find themselves in a negative cash flow situation during the early years of operations. Owners focus on growing their business, despite overhead and operating costs which are generally greater than the revenue that they generating for quite a while. This is a normal situation for many startup companies but an unsettling one nonetheless.
Finding themselves in the position of having to make up for diminishing operating capital, startups typically look to one of several funding sources—from bootstrapping or traditional business loans to investor seed money and venture capital—to keep them afloat while waiting for their revenue to increase and reach profitability.
Yet, convincing a funding source to get or remain involved is not simple and many startups struggle to explain their financial situation or capital needs. What startup companies really need—and often lack—is a clear understanding of their burn rate and the reasons behind it. In short, they need to learn how to keep their burn rate from burning them.
WHAT IS YOUR BURN RATE?
A startups burn rate is, in its simplest form, your expenses less income. It is the rate at which money is flowing out the door, offset by any revenue coming in. Ultimately, a good measurement of your burn rate will give you a better picture of how long you can continue to operate at the same level without needing to raise additional funding. On average, investors expect each segment of funding to last from a year to 18 months. If your burn rate indicates you won’t meet expectations, you might run the risk of not receiving future funding.
Startup companies can face trouble many ways during their startup period, not least of which is simply running out of cash. While this is sometimes inevitable or unavoidable—perhaps the startup is just not viable or there isn’t enough interest among investors—many times it is a result of an inaccurate financial picture. There are several reasons for this happening, all of which have fairly simple fixes.
MANAGING YOUR CASH
Managing your burn rate relies on a mix of several practices, starting with proper financial understanding and reporting to alternatives to direct cash outlays.
Financial Best Practices:
- Review your burn rate (at least) monthly to make sure you have a clear financial understanding.
- Manage your burn rate daily to ensure adequate control over expenses.
- Track and code every expense as they occur.
- Record and assign revenue to the appropriate calendar month—this is especially important if you sell anything that spans multiple time periods, such as an annual license or a monthly membership.
- Anticipate future large cash outlays so you aren’t surprised by a jump in your burn rate in the future.
- Reduce time and money spent on operational and administrative activities by hiring virtual or outsourced employees, such as bookkeepers, administrative assistants and even legal support.
- Be patient and prolong taking your product to market. The expense to hire and manage sales staff and marketing will be wasted if your product isn’t ready yet.
By employing a mix of financial best practices as well as exploring alternatives to larger, more traditional expenses, you can ensure that your startup is a lean operation with a manageable burn rate which will give it a greater chance of successfully going to market. The slower your burn rate, the greater likelihood your startup receives funding, gets to market, and becomes profitable.
At Net Profit, one of our specialties is helping businesses manage their finances while the company moves to the next level in its maturation process.
Whether your company is a startup or a mature entity, we are cash flow experts, contact us at 330-620-2761.