Posted by Early Growth
August 15, 2016 | 4-minute read (794 words)
There is one constant for all entrepreneurs to focus on that dictates whether you will succeed or fail. That is being strongly aware of your burn rate from the start. At any stage in a business this will be the pulse of how strong your operation is running. While some may dismiss the need to think about it until VCs enter the picture that is a costly and potentially disastrous mistake.
Burn rate needs to be on the mind of every founder at all times. In order to illustrate what makes up thinking about burn rate as effectively and efficiently as possible consider this checklist.
Determine burn on an accrual basis
When setting up accounting for a business, especially for an early stage company, choosing to use accrual based accounting to get GAAP compliant as early as possible. With a cash-based accounting all transactions are logged only when cash is received, as in the case of revenue, or as they are paid out as expenses.
It can be tempting to run with a cash-based accounting system to avoid overestimating reserves, but properly understanding and managing your Cash Flow statement can help mitigate these concerns.
Net vs Gross Burn
There are monthly expenditures in operational cash flow and there’s what it really is costing. With gross burn you are looking to capture a picture of the first to accurately see what supporting each aspect is consuming of your capital. With net burn you take that overall image and factor in the revenue created.
A simple illustration of this: if you are spending $100,000 monthly while pulling in half that, $50,000 in sales, then your gross burn is $100,000 while your net is $50,000. Investors will be focused on that net. What you need to be aware of is how the net can change. Whether it’s through overhead fluctuations or profit margin changes.
Gross vs net of course also comes down to whether your company is at a revenue generating stage yet. For many, especially in the tech sector, gross burn will be the only concern until a revenue stream has been developed.
What’s your timetable?
Once you have a burn rate projected you need to calculate that against on hand reserves of capital. This will allow you to make strategic decisions like whether to boot strap or if it would be better to seek investors. There are advantages to staying independent and bootstrapping. A burn rate forecast will allow you to calculate how possible that is. On the other hand, that may not be an option.
To get an idea of how a timetable influences the need for pursuing investors consider the following: Conventional wisdom has been that at the 6 month mark a fundraising process should be initiated.
This is shorter than I would recommend, especially in the current financial climate. As a leading source of providing financial services to startups, we strongly urge founders to start the fundraising process at the 9-month mark.
At the 3 month mark a company should be very active and close to done with any needed investment. Anything less than that is a big red warning light on the dashboard.
Variable expenses are the best control
If a burn rate needs to be tamed the first and most powerful option is looking at the variable costs that impact and shape it. It can be tempting to take on bloated fixed costs by choosing to lease large, flashy space to attract both clients and hot talent pools. Making those kind of choices locks in fixed costs which limits flexibility. Providing perks and projecting success ahead of accomplishment is a downfall heard often in assessing how early stage companies failed. As their name implies, fixed costs can’t be changed easily.
Examine where outsourcing and project decisions can be set up to be varied as needed. Alongside choosing to spend less on space, a project by project spend and a minimal staff keeps a burn rate manageable and responsive. Utilize contractors as needed, evaluate the ROI on all spend and keep focus on being lean whenever possible.
Keep burn rate needs on your mind at all time. Consider the checklist above to allow your thinking, and thus your choices, to be as effective and efficient as possible.
Since burn rate is the one constant that dictates whether you will succeed or fail, being strongly aware of your burn rate from the start will prevent costly and potentially disastrous mistakes. The pulse of how strong your operation is running depends on your attention and care to your burn rate, even before VC’s enter the picture.
Early Growth Financial Services provides constant burn rate calculations to its clients on a monthly and ongoing basis.