Do you even know what cash burn is?
These days it seems it’s incredibly easy for someone to set up in business and perhaps even do quite well for a time – but then soon enough growth kicks in, with unplanned for momentum – all good but alas things can collapse around their ears fairly easily. Most companies do not close for lack of a great product but for lack of great process and business understanding. Knowing about cash burn is one of these things.
Your cash burn rate is essentially the rate at which you spend your money. When you first start out in business – especially any business with a physical product which you need to manufacture and ship before receiving payment – you will have a high burn rate. (Suppliers offer no credit; you have no track record, therefore no funding available; you have no proven competency.) This is to be expected, but that doesn’t mean it is not something to also be monitored closely.
A monthly, even weekly, sometimes daily check of cash burn is the proper measurement that allows you to make sound sales decisions. It is also something that will always stand you in good stead knowing how the impactful decisions you make will affect your ability to trade well, trade freely and grow fast. If you ever need to approach a bank for funding (bansk are cheap funding and will support good business plans with a track record.) knowing your financial levers is priceless. Budget versus actuals, the effort you place on collections of debts, the knowledge you have about your creditors and the way relationships work that can perhaps give you flexible breathing space.
I used to have to call Buckingham Soaps on a regular basic begging for a few extended days of credit at month end. They were growing well off the back of our growth and helped share the burden of us supplying our slower paying customers. They even helped with a stock reserve at one stage and we also benefitted from continual dialogue where we shared and benefited from innovative solutions to market change and demand.
Profit on a deal, including the time that it takes to pay you back, is the real cost of the cash applied to a deal. It is important to make any spending decisions based on the whole picture of funding a product through manufacture, sale and finally payment. Indeed often in customised development for a product, perhaps for a special project, you need to think of the “what if,” situation for when perhaps you do not get the deal, what about costing in all that wasted opportunity cost if you have been distracted and not converted the deal? Opportunity cost can burn cash a long way into a clients first purchases. As Pacific Direct became bigger the opportunity costs of rolling out a big project was huge and could take months of profit, hence serious risk.
Think export, think pro-forma advanced payment sales and think bigger drops and one single invoice transaction. These are the points of export never to forget. Never ever give any credit internationally until there is a solid track record of payment and regular order repetition with an established relationship. Do not just know one person in an international partnership. Who writes the Purchase Orders, who is going to pay the bills following whose sign off???
At Pacific Direct when cash was very tight I put a great deal of effort into sales in countries where a letter of credit business growth was possible without a drain on cash, and by utilising extended credit facilities from suppliers with whom we had a good relationship.
But how do you extend your supplier relationships without damaging the flow of goods? The solution is simple if you have worked hard at your supply chain relationship. What you need to do is get on the phone to the supplier whose terms you might need to be be stretching. This might mean staying up very late or getting up very early in the morning if your suppliers are overseas, but still it must be done. Any supplier will benefit from your continued growth and if you talk to them when cash is tight they may be able to help. You can then agree a revised short-term payment plan and stick to it. You may even afford a slight premium (like an interest rate) on the goods but avoid this as it can stick.
Too many people ignore the fact that a supplier’s possibilities are affected by your slow payment – and in the long run you could be shooting yourself in the foot. Clearly a balance needs to be found when it comes to the buying decisions you make. Try first to estimate the impact any new spend might have on your company. A large spend obviously requires time and research but ultimately if your existing system is not working and you are wasting cash, you need to put in new changes immediately and stop the rot. This might mean applying cost savings, perhaps trialing a new approach – while you continue to squeeze the value out of the deal. The freight relationship looking forward is also a possible money source and of course tightening payment terms on the customers selling your goods well is an option.
It is important that while looking to make savings and increase value, you never go beyond what a supplier can afford to sell to you for. A service will be provided to the level that you are paying, and in the end if you get carried away with negotiating a lower price your business may suffer because of it.
Your cash burn should show you how much cash you are going through on average every week or month. If you divide your bank balance by your cash burn it will tell you how long you have in weeks or months before the cash runs out. This figure is arguably the most important in your business. Can you pay the salaries, (not including your own,) build in new stock orders and keep the goods flowing? What break could hurt? An online disaster, a major flow customer changing their flow of ordering, do not run without a small buffer if even possible, albeit I did this repeatedly and somehow squeezed through. If you are a funded business based on investor support, do not take that money for granted; it can be switched off if you are not getting traction.
If sales halt overnight and you have no cash coming in, how long will your business survive at the current rate of spending? You might think this is a worst case scenario and not likely to happen but when 9/11 happened I was in a very sticky situation. Overnight, people stopped travelling. Everyone was scared to fly, and so hotels were losing money hand over fist. This meant they cut their orders from Pacific Direct and in some cases went under completely – which meant I lost clients and my turnover dropped dramatically. I was able to weather the storm only because I knew my cash burn rate; when the money coming in went from a flow to a trickle, I knew how long I could keep going before things got really bad, and that meant I was able to go out and sell to other clients in other markets and get us back on our feet again. I could also go to the bank and ask for an extended loan but by then we were well known, well established and had been trading a long time. Track record counts for a great deal.