Why Burn Rate Matters

There are specific financial metrics you need to monitor consistently, and your burn rate is one of them. Failing to track your burn rate may lead to running out of funds sooner than anticipated. Moreover, it can hinder your ability to hire key personnel because you might assume you can't afford them.

Investors will frequently inquire about your burn rate, expecting you to provide an immediate answer. This underscores its significance in the startup landscape.

What Burn Rate Is Not

A common misconception among startup leaders is equating burn rate with the total money spent over a certain period. While it’s crucial to know how much you're spending each month, that’s just one aspect of the overall picture.

What Burn Rate Is

Your burn rate represents the difference between the cash coming into your business and the cash leaving it each month. It’s important to clarify that this refers to cash collected, not just revenue, which brings us to the next point.

Understanding the cash flow—cash in versus cash out—gives you a clearer understanding of when you may run out of funds. This insight is vital because a business cannot operate without sufficient cash flow.

To effectively manage your finances, it’s necessary to project future revenue.

How to Calculate Your Burn Rate

Keep in mind the formula: cash in minus cash out. Start by closely examining your outflows. Salary expenses typically constitute the majority of your costs, so you need to track these carefully. Ensure you also account for any overhead costs linked to your employees, such as healthcare in the US.

In addition to salaries, consider rent, subscriptions, office supplies, travel costs, marketing expenses, and production costs (Cost of Goods Sold). It's essential to estimate these expenses as you plan for the future.

Now, let's shift our focus to the revenue side.

Startups are often overly optimistic about revenue projections. As my late colleague, Barry Cox, once shared with potential investors, "Startups struggle with forecasting revenue, and we are no exception."

While it’s true that forecasting won't be perfect, developing a habit of estimating future monthly revenue is beneficial. With practice, you can improve your forecasting skills over time.

Using Your Burn Rate for Decision Making

Your burn rate is dynamic and influenced by various factors. Here are some strategies to leverage your burn rate effectively:

1. Align Hiring with Revenue Plans

   If you're not generating revenue yet, tie your hiring strategy to the progress made instead.

2. Maintain Multiple Forecasts

   Although it may seem daunting, having best-case, nominal, and worst-case scenarios can guide your hiring decisions. Adjust your hiring plans according to these forecasts, and update them monthly.

3. Hire a Fractional Controller Early

   Engaging a part-time controller can significantly aid in financial management. For instance, Tina, who initially worked just one day a week with us, became instrumental in integrating our forecasts with our financial plans. Weekly meetings ensured we reviewed our financial status and made necessary adjustments.

4. Adjust Cash Flow Based on Revenue Timing

   Cash collection often differs from reported revenue. For example, if you invoice customers with net thirty terms, you might receive cash only after a month, even if you report higher revenues.

For clarity, let's consider a scenario: If last month's revenue was $50,000 and this month it rises to $100,000, but your customers are on a net thirty payment schedule, you may only collect $50,000 this month.

Final Thoughts

As the CEO, it’s crucial to maintain tight control over company expenditures. One effective method is to personally approve all spending—avoid distributing company credit cards, and sign off on every check. You will likely be the only one in the company who fully understands the significance of conserving funds. This practice was one of the most effective strategies I employed in my role as CEO.

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