The three critical tests of your cash control
Wednesday, January 11, 2012/
Start-up businesses are cash hungry. It takes cash to fund the initial development and ongoing growth of the business.
With the initial months, or for innovation businesses, years, of costs and investments returning minimal revenue, it’s important to closely monitor and control your cash burn rate.
With this in mind, there are three important cash KPIs to measure:
- Cash burn rate
- Cash zero date
- Cashflow breakeven point
The cash burn rate shows how much cash you’re burning each month and how long your existing cash will last.
Using a simple example, if you start your business with $100,000 of investment capital and you’ve spent this after 10 months, your burn rate is $10,000 a month.
If you don’t reduce your burn rate, start making money or provide an additional injection of funds into the business before the tenth month, you’ll run out of cash.
Cash zero date is based on your cash burn rate and is the date at which your current cash will run out. This provides a worse case scenario if no additional revenue or funds become available.
However, it’s important to know and put to good use in your financial management and business decision-making processes.
Cashflow breakeven point is the point at which internally generated cash, typically from revenue, covers the cash outflows of the business and the date at which breakeven occurs.
You need to make sure you have enough cash to cover outflows until the breakeven point is reached.
A shortfall in cash needed to reach breakeven would need to be met by external funding sources.
To put these KPIs to good use, here any my top five tips to stay on top of cashflow:
1. Prepare forecasts
Compare actual results to those forecasts and update them to reflect the reality of your cash position.
It’s impossible to consistently predict the future.
Just think how often economists get it wrong. Therefore it’s essential that forecasts are updated to reflect reality.
2. Assess your cash burn rate, cash zero date and cashflow breakeven point
Ideally, you would estimate this as part of your planning and forecasting, before commencing the business.
This gives you a head start on allowing for your cash needs. Then as the business operates, assess your burn rate based on actual spending and how that impacts the other two KPIs.