Investopedia defines the Cash Burn Rate as "The rate at which a new company uses up its venture capital to finance overhead before generating positive cash flows from operations. In other words, it is a measure of negative cash flow." But established businesses who are planning change should look at their Cash Burn Rate too. Even profitable companies can have negative cash flow. You don't want your cash flow to get dangerously low, however, as then a slight breeze could tip you into receivership.
Formula for the Cash Burn Rate:
Total cash position change/specified time period
For example, say you had $200,000 in the bank on January 1, and $120,000 in the bank on 31st December. That means you are burning up $80,000 a year or $219 per day.
What is your Runway?
The Runway is also referred to as "Days to Zero Cash". I prefer this term, because, being a bit more dramatic, it might inspire corrective action. Startupdefinition.com defines the runway as "The amount of time until your startup goes out of business, assuming current income and expenses stay constant."
Here's the formula for "Days to Zero Cash"
Cash Reserves (i.e. cash available)/Burn Rate
So taking our previous example which resulted in a burn rate of $219 per day and now you have a bank balance of $30,000, you can only keep your doors open for another 137 days or 4.5 months.
These formulas are a load of rubbish!
There are so many problems with these two measures, Cash Burn Rate and Days to Zero Cash, I don't know where to start. Sure, if you are an investor, sometimes all you have is published data, such as the Balance Sheet, Profit and Loss and Cash Flow Statement on which to do the calculation. But I would never calculate Cash Burn Rate or Days to Zero Cash for a business client using these formulas. The main problem is that the calculations are based on historical information and averages and not specific future plans. Let me put it another way: If I told you you could only trade for another six months before going under, would you take me seriously and do something about it?
Solution: forecasting software + thought + investment in time
In my experience with established businesses and using solid cash flow forecasting software:
feed in about 18 months of solid historical data so that you can identify trends and clearly see causes and effects of past actions;
feed in what your plans are for the future;
feed in all the assumptions and variables you can think of with regards to the economic environment, both within the company and external.
Try to build in 'interconnections' in your model, both financial and non-financial. For example, if you want to invest in a piece of machinery next July, you will need to put in your model:
the cost of the machinery and its installation;
the finance for the machinery including expected interest rate and timing of the repayments;
allocation training of staff for the new machinery;
amount and cost of disruption to production during the installation;
Then, press the button and see what is most likely to happen to your cash flow.
The forecasting software should calculate your Cash Burn Rate automatically - then the real fun (work) begins!
Get into that playpen and do some scenario planning to see what effects it has on cash flow;
Get regular 'Budget/Actual' reports to see how well you did at crystal-ball gazing;
Re-visit your forecast at least every quarter and adjust.
Final tip: the Cash Flow Forecasting software should rely on both Balance Sheet and Profit and Loss items to calculate the cash flow.
It sounds like a lot of work, and it is, but very worthwhile because you end up with better control over your Cash Burn Rate. And more control means you sleep better at night!