Portfolio companies face the ongoing challenge of balancing growth at all costs with efficient cash management. During periods of rapid expansion, your company is experiencing significant cash burn as you secure vendors, purchase additional equipment, onboard more employees, scale operations or expand across borders. While fueling growth is essential, it’s equally crucial to maintain a healthy and productive cash burn rate.
To effectively manage cash burn, businesses must embrace mindset shifts that prioritize data-driven decision making, cost optimization, and strategic allocation of resources. By adopting these new perspectives, companies can extend their cash runway and position themselves for a sustainable future, regardless of their size or stage of development.
What Is Your Current Cash Burn Rate?
Cash burn is a measurement of how much reserve funds or balance your startup uses each month. Your cash burn rate signifies how fast you’re spending it. Although you may only be spending more every two to four months, calculating the rate on a monthly basis gives you a closer look at your daily expenses.
There are two cash burn rates that you can measure: net burn metrics and gross burn metrics.
- Net burn rate: Includes your spending while considering any profits made during the evaluation period
- Gross burn rate: Includes spending while leaving out your profits
Let’s say you started with a cash balance of $300,000 in January and $100,000 in April. Breaking it down to monthly, your business spent $50,000 per month. You subtract $100,000 from $300,000 to get $200,000. Then you divide $200,000 by 4 (the number of months) to get $50,000. This figure would be your net burn rate.
Understanding your cash burn rate allows you to determine your cash runway, or how long it will take to burn through your entire cash reserve until it’s depleted.
To figure out your cash runway, you take what cash you have now in April ($100,000) and divide it by your net burn rate ($50,000). You have a cash runway of two, which means you have two months before your business runs out of cash reserves.
Keep in mind that even though your cash runway may be two months, you may be expecting high revenue in those months that offsets spending. You’ll want to make changes if you don’t expect your revenue to change or if it will decrease during those months. A good burn rate should allow you 12 months of runway—enough time to fundraise before that runway is gone.
You can also calculate your revenue growth rate, which measures the percentage increase in your company’s revenue over a specific period, calculated by comparing current and previous revenue. The higher your revenue growth rate against your expenses, the more manageable your cash burn will be.
4 Business Shifts for Strategic Cash Burn Management
High cash burn is not negative if it’s resulting in rapid customer acquisition or growth. However, startup founders can get into certain mindsets about cash that can negatively impact their operational growth. Shifting from these mindsets allows you to better allocate your spending, address wasteful spending and invest your cash in the most growth-positive ways.
Shift to Disciplined Growth Investing
Founders are pressured to pursue rapid growth, even if it means depleting cash reserves. But that doesn’t mean you should simply lower your burn rate—after all, your investor funding is there specifically for the purpose of using it to grow quickly. However, if cash burn is not productive, the “growth at all costs” mindset can lead to wasteful spending on initiatives that don’t generate positive ROI. To manage cash burn effectively, founders must adopt a disciplined growth investing approach.
A disciplined growth investing strategy involves closely analyzing the expected ROI of every expenditure and prioritizing investments that drive more revenue. This means moving away from “vanity metrics,” which can become costly black holes with little to no return. Focus your cash on initiatives that contribute to long-term success. Are you investing in marketing initiatives that show a positive growth in traffic, but little to no growth in actual engagement or conversions? Are you investing in top talent or just more talent?
Embrace Optimized ‘Cost Allocation’ Over Indiscriminate Cost Cutting
When experiencing uncontrolled spending, the easiest way to deal with it is to cut costs across the board. You’re decreasing spending in all departments. However, cutting costs everywhere may not lead to positive ROI. Your investors will wonder why you’re not spending funds and your momentum may not recover. Instead, you’re starving certain operations that require spending to become stronger until they ultimately fail.
Instead, you should consider shifting from a cost cutting mindset to a mindset of optimized cash allocation. Look at areas where you can increase output and place your funds there to get more bang for your buck. Leverage tools such as automation technology and outsourcing to help operational efficiency and cut costs effectively. You can also shift employees’ work and time towards activities that are high in value and more revenue-driven.
Assume a Risk-Aware Mindset
Even when cutting back on wasteful spending, unexpected circumstances and speed bumps can increase spending. You should identify potential disruptions that can impact cash flow and create proactive risk mitigation strategies to weather through unplanned events.
Reassess your insurance coverage, contingency funds or cash buffers you have in place for these specific events. Then revisit business forecasts, consistently monitor variances and adjust operations when needed for more proactive cash flow management.
Don’t Ignore the Role of Data Analysis—or Finance—In Your Growth
To manage spending and achieve sustainable growth, you need reliable data to guide your decisions. Your finance function plays a crucial role in this process, as important as your sales and marketing teams in driving growth. Your finance and accounting professionals compile and analyze this data, helping align your operations with the company’s financial goals.
Investing in financial data analysis allows you to understand where your money is going and where it’s most effective. A centralized financial reporting system with dynamic dashboards can consolidate data from all departments, eliminating the need to track down information manually. Then, you can use this data to evaluate dollars spent and where those dollars are most productive.
Continuous forecasting and budgeting are also key to effective analysis, especially when enhanced with predictive analytics tools. With accurate data and analysis, you can adjust your growth strategy based on concrete metrics, reducing the risk of wasteful spending and promoting long-term success.
Start With a Spend Audit
You have a lot going on with your startup when it comes to controlling spending and growing your customer base. Yet take some time to perform impartial spend audits of your operations. A spend audit allows you to identify inefficiencies and waste.
Once identifying and remedying wasteful spending, you can adopt lean operating practices to streamline processes without stifling business growth. You’re able to make your operations more financially stable, allowing you to then prioritize your spending on high-margin initiatives. Consider all avenues, whether that’s to adopt new pricing models to improve your cash flow dynamics or creating cash burn KPIs to monitor progress and track expenditures.
The Long-Term Payoff of Healthy Cash Burn
When you strategically manage your cash burn, you develop a healthier cash runway geared toward achieving sustainable growth. You increase your financial independence to spend your cash reserve more wisely on sound business investments. In addition, investors gain confidence regarding your smart business decisions.
Get Expert Support to Extend Your Runway
You can overcome the cash burn paradox by shifting your mindset and strategies. Develop a more effective growth strategy while optimizing your cash burn. Partner with Paro’s fractional finance experts to implement effective cash management and to gain the hard metrics to analyze your operations. Schedule a free consultation to learn more about how we match businesses with vetted, top-tier experts.
