Liquidity Analysis: Cash Burn Rate

Cash Burn Rate: Assessing Cash Consumption and Survival Period

Introduction

Understanding how a company uses its money is important, especially for new businesses. We use something called the cash burn rate to see how fast a company spends its money. This helps us figure out how long the company can survive before it needs more money. In this section, we will learn about the cash burn rate, how to calculate it, what it means, and why it's important for a company.

Understanding the Cash Burn Rate

The cash burn rate tells us how quickly a company spends its money. We look at how much money the company had at the beginning of a specific time, like a month or three months, and how much it has at the end. Then we find the difference and divide it by the time period.

Cash Burn Rate = (Beginning Cash Balance - Ending Cash Balance) / Time Period

Interpretation of the Cash Burn Rate

The cash burn rate helps us understand if a company is doing well financially. If the cash burn rate is high, it means the company is spending money quickly. This could mean the company will run out of money sooner and need more. But if the cash burn rate is low, it means the company is being careful with its money and can keep going for a longer time without needing more.

Significance of the Cash Burn Rate

The cash burn rate is very important for new businesses, like startups. It helps us figure out how many days a company can keep running with the money it got from investors. By keeping an eye on the cash burn rate, companies can understand if they need more money, if they should spend less, or if they are doing okay.

Considerations for Startups

For startups, the cash burn rate is a super important number. It helps them know how long they can keep going with the money they have. This assumes that the company won't make much money during that time and will only use the money it got from investors.

Example:

Let's pretend there's a startup called Company XYZ. Here's some information about it:

Beginning Cash Balance: $1,000,000

Ending Cash Balance: $800,000

Time Period: 3 months

To find the cash burn rate, we subtract the ending cash balance from the beginning cash balance and divide it by the time period:

Cash Burn Rate = ($1,000,000 - $800,000) / 3 months

Cash Burn Rate = $200,000 / 3 months

Cash Burn Rate = $66,666.67 per month

In this example, Company XYZ has a cash burn rate of around $66,666.67 per month. This means that the company is spending about $66,666.67 every month. Based on this rate, we can estimate how long the company can keep going before it needs more money.

Conclusion

The cash burn rate helps us understand how fast a company spends its money and how long it can survive with the money it has. For startups, this is a very important number. A high cash burn rate means the company is spending money quickly and might need more soon. A low cash burn rate means the company is using its money carefully and can keep going for a longer time. By keeping track of the cash burn rate, startups can make smart decisions about money, costs, and their future to be successful in the long run.

This article takes inspiration from a lesson found in FIN 689 at Pace University.