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Cash isn’t like calories. Those, you want to burn up fast. But when it comes to the cash consumed by your startup business, the slower your “burn rate,” the better.
Knowing the burn rate in your new business and managing it well will tell you – and indicate to your investors – when you’ll need more investment or a loan, or when you will break even and begin to make a profit.
If you forget to check this compass within your new business, you could run out of cash before you reach those milestones – and find yourself burnt out of business.
Learn to calculate the burn rate for your startup business
Simply put, your burn rate is how much capital you go through each month. When you start up, you begin with a specific amount of capital – let’s say $100,000 as an easy example. You decide that it takes $10,000 a month to operate your new business, with no revenues projected during the first year. That means your burn rate is $10,000 a month. In this example, you’d be in trouble if you don’t start making money by your 10th month in business.
As a rule, you need to review your burn rate every month, just as you do the components of the burn-rate equation: expenses and income.
“It’s no different for a company than it is for an individual: How much do I make a month, and how long is it until payday?” says David Brophy, a professor of venture capital at the University of Michigan. “It’s as old as dirt and as fundamental.”
Carefully monitor your burn rate
If your heart rate gets too high or low during a workout, you’d better figure out what’s going on. The key to understanding your company’s health is to monitor its burn rate.
“Devise a barometer,” Brophy advises. If you already have revenue, this can boil down to keeping a fastidious eye on your order book and your cash-flow statement. “By watching them,” he says, “you’ve got your finger on the whole working-capital system of your company – and your burn rate.”
And it may pay to get even more sophisticated in monitoring your burn rate. Dwight Schultheis, for one, has developed a financial-projection model that he compares against the actual monthly performance of his New York-based company, Amenity LLC, which provides men’s personal-care products. Then he reports variances to each of his managers and investors.
Keep your regular business expenses in check
Obviously, one of your burn rate’s two components is easier to control than the other. You can’t unilaterally produce revenues for your company, but you can single-handedly control expenses. And you should be ruthless about it, particularly in the early going. Monitor expenses every day.
Lea Ellermeier Nesbit tries to save money every time she turns around, to keep a safe burn rate for her startup, Lingualcare, until the Dallas-based company begins selling significant numbers of its innovative tongue-side orthodontic braces. Nesbit scouted out bargain-basement office space and then hit up the landlord for free use of cubicles, office furniture and phones. She outsources nearly every service, including accounting and marketing, to cut overhead. And, for now, Nesbit and her partner are taking company stock instead of salaries.
Think twice – at least – before committing to big outlays
You should keep major outlays and significant new financial commitments to a minimum, especially while you have to aggressively manage your burn rate. Once you decide to incur a big expense, take another day to think about it first.
At least make sure you’re placing the right bets. That may mean adding salespeople before a financial manager. Or buying a new shipment of inventory – you know customers will lap it up – before gorgeous new office furniture that makes you feel good. Spend your precious cash on what’s critical to producing revenue for your startup business.
Go back to the well for more capital
If you’re doing everything possible to contain expenses, but adequate revenue remains just over the horizon for now, you may simply have to add fuel to the fire – and get more capital for your startup business.
Even if you haven’t sold a dime’s worth of products or services yet, you might be able to obtain that capital cheaper than when you started up. “When the markets are good, there’s lots of money out there trying to find companies to put it into,” says Tony Grover, head of RPM Ventures, an entrepreneurial financier based in Ann Arbor, Mich. “Negotiate hard and get cheaper cash.”
And while raising money by parsing out equity is one thing, entrepreneurs warn against taking out more loans or adding other debt – avoid it like the plague. “We don’t accumulate debt,” says Richard Wingard, head of Euclid Discoveries, a Concord, Mass., startup business that is developing video-compression technology. “It’s like getting a credit card in the mail: it’s too easy. But don’t do it.”
Our Bottom Line
Controlling your burn rate can give you the confidence and resources to ramp up your startup business the way you want. Squeezing expenses in that new business is the best way to do it. If you don’t, you’ll learn just how unforgiving the marketplace can be.