Small businesses face unique disaster recovery challenges. In this article, The Ascent shares a guide to help you prepare your small business for disasters.
If you’re like any other business, you’re watching the markets closely amid the COVID-19 coronavirus outbreak and wringing your hands, at least a little. Many thoughts are probably running through your head: What if the crisis hit me? How long can I survive without money?
If you want to know how long your business can keep its doors open during a crisis, you should immediately calculate your “cash reserve burn rate” or “cash burn rate”.
Overview: What is the Cash Burn Rate?
The cash burn rate refers to how quickly your business is spending its cash reserves. By determining what your burn rate is and how much cash reserve you currently have, you can determine how long your business could stay open before running out of cash.
It’s useful to know this even when you’re not in crisis, because then you can set financial goals, such as whether you want to increase your reserves so that your business can stay open for three months.
How do I calculate my cash burn rate?
Calculating your cash burn rate is quite simple, involving a relatively simple formula.
You can choose between two types of utilization rate: your current utilization rate, which calculates how much you have spent as a business during the previous month, and your average monthly utilization rate, where you take this rate of use and average over, say, 12 months.
These formulas are calculated like this:
- Previous month’s cash balance – current month’s cash balance = current consumption rate
- (Cash balance 12 months ago – current cash balance) divided by 12 = average monthly consumption rate
So, for example, if your business currently has $200,000 in cash reserves, and $250,000 a month ago, the current burn rate is $50,000, and the business would still have four months to go. run out of cash.
If your business has $200,000 in cash reserves now and $400,000 12 months ago, that means you have an average monthly consumption rate of $16,667 and you will run out of cash 12 months from now.
Now, if you’re planning to shut down completely for the next two months due to the virus, the math is a little different because you’ll be generating a lot less revenue.
In this case, you need to make an estimate: write down the amount of your monthly income you think you can withdraw during this period, assuming it is greater than zero, and estimate how much you could reduce your monthly expenses. . The difference will be your monthly consumption rate.
So if, say, you’re a restaurant that’s closing and doing only delivery, and you expect monthly revenue to go from $100,000 to $10,000 a month, but you think being able to reduce monthly expenses from $75,000 to $25,000 during this period, your monthly consumption rate would be $15,000.
If you had $45,000 in cash, that would give you three months before you needed a loan to stay open.
How can I reduce my cash burn rate?
A crisis can present a significant opportunity for a business to find creative ways to reduce costs and position itself better financially at the end of the crisis than at the beginning.
Here are some ways to use this situation to reduce your costs:
- Renegotiate with your suppliers: They are also going through the crisis and understand that their clients are suffering. See if you can find a deal where you save some short-term money in exchange for longer-term incentives on their end.
- Find other sources of income: As mentioned above, a restaurant can avoid directly losing revenue by offering some sort of takeout or delivery service during a pandemic. It may not entirely replace sitting business, but it can help soften the blow.
- Find and dispose of waste: Look for opportunities across the business to cut costs, whether it’s ensuring lights are off except where lighting is absolutely necessary or dramatically reducing discretionary spending. The little things can add up.
Tighten up to survive and stabilize
Calculating your burn rate and making tough decisions to contain it and slow it down will go a long way to ensuring you weather this storm. You can take further action that go beyond strictly financial concerns to stabilize your business, your employees and your customers.