Ways to manage cash burn during a market downturn
When I made the change from consulting to an FP&A role at a startup I was shocked by how much cash we were burning. Like many of you who might have made a similar transition, I quickly learned this was all part of the game.
With the markets returning to focus on cash flows and demonstrating a path to profitability, valuations are no longer linked to growth at all costs.
Here are three ways to gauge cash burn, with real life examples:
- Cash Runway
- The Rule of 40%
- Burn Multiple
- Cash Runway
- Cash Runway is the number of months you have until cash runs out. Managing your cash runway is dependent on your future capital strategy. Are you running the business with plans of raising again? Or do you want to become self-sustaining?
- If you're on the venture path, post-fundraise you typically want a cash runway of at least 18 months. This gives you 12 months to go out and make magic before coming back to the table with your coffers, plus another 6 month buffer in case the markets aren't in great shape.
- Here's a hypothetical example of cash burn that I spun up. As you can see, going into month 8 you'll need a cash infusion
2. Rule of 40%
- Some investors validate a "good" balance between growth and profitability by checking if revenue growth rate plus profit (or loss) rate exceeds 40%.
- I personally think the Rule of 40% is a low-ish bar for most tech companies these days.
- But as a general rule of thumb across all industries, it makes a lot of sense. I also think there are diminishing returns past a certain growth rate. Investors aren't necessarily going to pay any extra for 125% growth vs 110% growth if you are losing 50% per year.
- They'd probably rather a financial profile that looks a bit more balanced, like 110% growth and 10% loss per year or 100% growth and breakeven.
- Remember: Not all growth percentage points are created equal.
- Here are a few examples of the Rule of 40% I spun up using earning releases. As you can see, Snap is the only one exceeding the threshold
- This metric evaluates your cash burn as a multiple of revenue growth. In other words, how much are you burning in order to generate each incremental dollar of ARR?
- In the words of investor David Sacks: "The higher the Burn Multiple, the more you're burning to achieve each unit of growth. The lower the Burn Multiple, the more efficient the growth is."
- I like the burn multiple as a rule of thumb because it quickly tells you if your spend is getting ahead of your commercial traction.
- Now let's do some math and apply the burn multiple to three fictional companies of varying scales. As you can see, although Company C is generating the most net new ARR, it's burning a lot more cash per unit of ARR.
In conclusion, businesses usually die because they run out of money. So keep an eye on your cash burn.
I write a newsletter about metrics and business stuff using what I've learned from my days in FP& . If you found this remotely helpful I'd love to share more