Burn Baby Burn
Remember in the 1980’s when there was a “War On Drugs”? And Michael J Fox did a commercial where he took an egg and said, “This is your brain.” Then he cracked it into a hot frying pan and said “This is your brain on drugs,” while the egg sizzled in the pan?
No? Well if you weren’t there or don’t remember then you missed out. The 80’s were pretty awesome.
Anyway, Michael was trying to show you an analogy that if you do drugs you are literally burning your brain cells.
Today I want to talk about burning cash. Here you are not literally lighting up bills, but rather spending it. You may have heard people talk about it in the startup world.
“What is your burn?”
“How high is your burn?”
“Don’t let your burn get out of control!”
What are people actually talking about here?
Burn is a really simple concept. Essentially you sum up all of the cash you bring in via revenue and then subtract all of the cash expenses that go out on a monthly basis.
Burn = Cash Received From Revenue - Cash Spent
Sounds easy enough, right? But I see people get all tangled up in accounting and accruals and counting received incorrectly.
I think what tricks people up is the revenue part.
One thing is accruals. And another is cash.
Yuck, sorry for the accounting lesson, but this small tidbit is important here.
You have probably heard your accountant say something like: “You must recognize revenue during the period in which your product is sold or your service is used.” And that sounds kind of confusing, but what he or she is saying that is that your income statement, which shows the revenue and expenses on an accrual basis shows an accurate picture of how your business is doing over time. Here you are matching up the revenue earned with the expenses at the correct time.
For example: you sell a subscription service for $120 per year and a subscriber pays for the year up front. On the income statement you will show the $10 in revenue per month (the total amount divided by 12 for each month of income) starting on the first day of service and ending on the last. This is accrual.
But for burn, we don’t care about all that. It is way easier. Burn is so easy that if you just have one bank account for your business you can simply look at the account statement each month and read the summary. Bank accounts statements typically cover calendar months. Go to your January statement and look at the summary. It will say: Deposits and Additions, that will be all of the cash that you received. Then look at the withdrawals and add them up.
Take the additions and subtract the withdrawals. Voila! You have your monthly burn.
There is one caveat though. In your deposits and additions if you have received cash from investors or banks (loans) or any other means which is not revenue, it cannot be counted.
Burn is meant to give you a quick picture of the business. How much money are you spending and how is your burn trending monthly. Although, with VC backed companies you will often see a J curve, on a graph where the trend of your burn goes down for a while until you start losing less money (which looks like a “J”), the objective of all businesses is to be profitable. (I bolded that because I think sometimes people forget that businesses need to be profitable otherwise they are charities.)
So let’s take the example again of the annual subscription paid up front. When you are calculating we don’t care about the day someone signed up or when they are going to use it. We care about cash in the bank. For calculating burn, the month that you receive the $120 is when you add the full amount to the Cash Received from Revenue column. Make sense?
A few more examples:
- You get a loan for $50 thousand in January. This is not counted in your burn calculation.
- You sign a contract for a $120 thousand dollar deal in January that starts March 1st. You get and get paid the full amount in February. Add $120 thousand dollars to the Cash Received from Revenue column in February.
- An agreement is made with your supplier to purchase $50 thousand worth of inventory where you pay 50% up signature and 50% upon receipt. You sign the agreement in March. Add $25 thousand to the Cash Spent column in your March burn and a $25 thousand placeholder for the month that you expect to receive the inventory.
The importance of calculating burn and creating projections for burn to give you a guide on how much money you are spending and when you will run out of money.
I hope this helps and you can get back to running your business. Don't burn too much cash too quickly...remember Cash Is King.