Author: Andrea Boccard, Marketing Manager at AccountingDepartment.com
Startup companies often find themselves dealing with a negative cash flow during the early stages of operations. Focused on growing their business, their investments, overhead and operating costs generally outweigh any revenue they might be generating for quite a while, a normal situation for many startup companies but an unsettling one nonetheless. 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 above water while their revenue increases to profitable levels. Yet, convincing a funding source to get or remain involved is not nearly so 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 financial picture behind it. In short, they need to learn how to keep their burn rate from burning them.
What Is A Burn Rate?
Your startup’s 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 clear picture of how long you can continue to operate at the same level without needing to raise additional funding. On average, investor expect each round 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—and end up losing everything.
Startup companies can run afoul many ways during their infancy, not least of which is simply running out of money. 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.
Avoiding The Burn—Rate, That Is
Managing your burn rate relies on a mix of best practices, from 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 picture.
- Manage your burn rate daily to ensure control over expenses.
- Track and code every expense when 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 for software or a monthly membership.
- Mind anticipated future large cash outlays so you aren’t surprised by a jump in your burn rate down the road.
Alternatives to Big Expenses:
- Offer equity or future revenue to lower employee salary costs and offset a lack of employer-sponsored benefits.
- Consider shared spaces, co-work environments and BYOD policies to lower overhead costs and reduce IT expenses of managing and fixing issues.
- “Rent” developers or other professionals through startup labs and incubator programs instead of hiring a large, full-time team.
- 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 expenses to hire and manage sales staff and marketing will be wasted if your product isn’t ready yet.
- Consider cloud-based programs to reduce maintenance and server costs where possible.
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 and 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.
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