In the early stages of your company you will simply be spending, running at a loss, before emerging into profitability and positive cash flows. Because of this the two most common questions for early stage companies are: what is your burn rate? and subsequently: what is your cash zero date?
The metrics burn rate and cash zero date, both venture capital terms, are widely believed to have come out of the dot-com era when tech start-up companies went through several stages of funding to finance overheads before reaching positive cash flows.
Burn rate is really your average monthly costs - it gives people a feeling for how much you spend in a given month. So, for instance, if you were nine months into the year and you had spent $653,000, year to date, on operating expenses, regardless of revenues coming in, your burn rate would be approx. $72,500 ($653,000 divided by nine months and rounded off). Because startups experience extreme contraction and expansion, you usually take an average of the previous twelve months expenses to smooth the metric out.
The next metric is the cash zero date. This date tells your audience when you run out of cash (e.g. cash is equal to zero). A very rough calculation is to take your cash position on a particular day and divide it by the average monthly burn rate and adjust for number of days. So, it would look like this:
Current date + ( cash at current date / (monthly burn rate * 3) * 91 days ) = cash zero date
What is with the “* 3? and “* 91? in the above calculation for? If you took cash divided by monthly burn that gives you the number of months and we want number of days because for most startups that is what it comes down to. By multiplying the monthly burn by 3 to give us a quarters worth of expenses and then the whole calculation by 91 you get days (because it is believed there are 91 days in three working months, and 364 days in a working year).
So, given our example above, say today’s date is March 31, 2008 and you currently have $163,963 in cash with a monthly burn rate of $72,500. The calculation would be:
March 31, 2014 + ( 163,963 / (72,500 * 3) * 91 days ) = June 7, 2014
Another way of casually saying this would be: “we have roughly $160K in the bank and we burn at a rate of $72,500 a month.” If it was March 31, your audience would know that you had approx. two months before you ran out of cash, assuming no other cash came in.
This last statement, “assuming no other cash comes in”, is a very important distinguishing point. As mentioned earlier, these are venture finance terms for early stage companies where it is assumed there is NO cash coming in at all. Hopefully this is unrealistic for your company so make sure to always make that disclaimer when tossing these metrics out. It then let’s the audience know that your cash zero date is the worst case scenario.
When do you stop calculating cash zero dates? An ideal state for a small early stage company is to always be carrying 2-3 months burn, in cash, just in case you have a bad quarter. When your cash zero date starts to become a year or more out I think it is safe to say you can relax on providing the metric or do provide it to give peace of mind to your investors/audience.