Wherever you are in the startup life-cycle, managing your cash burn is essential to navigating risk. For example, how long will your current cash position fund the business? Looking to double headcount within the year, how does that change your current cash-flows? Raising capital, how much is needed to fund various growth scenarios, and how long will that capital last? In order to successfully guide your startup through each phase, nail the three cash burn principles below.
Gross cash burn: Operating expenses required to keep the business running. In other words, think of all the salaries, rent, software, T&E, AP, etc. Gross burn is an important metric to understand because it provides you with a base of knowing your monthly average cash out to operate the business. From this point, you can quantify how much sales the business needs to break-even and toggle different growth scenarios to drive to cash-flow positive or capital needs.
Net cash burn: Cash in minus Cash out – net cash burn is your cash profitability metric, which is all of customer payments minus company expenses (or gross cash burn). Important notes to make here, are payment,expense timing and financing, which I explain more below.
Cash runway: Length of time the business can cover its costs. To calculate cash runway, divide your current ending cash balance by net cash burn. Ideally, 24+ months of cash runway is a good target to maintain. Knowing your cash runway is essential in mapping out go-to-market fundraising. Whatever your cash runway is, subtract roughly 6 months for the fundraise process from pitch to term sheets to capital in the bank.
Anomalies to consider for your cash burn – Timing!
Remember, cash is a non-accrual item, so understanding the timing of your expenses is critical to mastering your gross cash burn.
Recurring versus One-time: Make sure you have categorized your AP systems to factor one-time expenses, so you don’t overstate cash-out when building your forecast or calculating your cash runway. Large one-time expenses can provide you with the incorrect cash burn by under or over stating expenses which can further impact hiring or growth scenarios, so make sure you have a handle on recurring and one-time expenses.
Commissions and Bonuses: When modeling your cash out, factor the timing of payments for commissions and bonuses. For example, does your comp plan pay commissions on booking, invoice, or payments? Each scenario will have various cash out timing which will impact your burn. The same is true for bonuses. Generally, most employee bonuses are paid once a year, but don’t forget to factor in the timing of quarterly performance bonuses.
Financing: Keep a separate cash burn line for financing. You won’t have a handle on your cash operations if you include any financing which would overstate cash in (cash draws) or cash out (principle/interest payments).