SMB Disaster Preparedness: Calculating Your Cash Burn Rate

Small businesses face unique challenges when it comes to disaster recovery. In this article, The Ascent shares a guide to help prepare your small business for disasters.

If you’re like any other business, you’re closely watching the markets in the midst of the COVID-19 coronavirus outbreak and wringing your hands, at least a little. Many thoughts are probably racing through your head: What if the crisis hits me? How long can I survive without money coming in?

If you want to know how long your business can keep its doors open during a crisis, you need to immediately calculate your “cash reserve burn rate” or “cash burn rate.”

Overview: What is cash burn rate?

Cash burn rate refers to how quickly your company is spending its cash reserves. By determining what your burn rate is and how much cash reserves you have right now, you can determine how long your business would be able to stay open before it ran out of cash.

It's helpful to know this even when you're not in a crisis, because then you can set financial goals -- such as if you want to increase your reserves so that your business could stay open for three months.

How do I calculate my cash burn rate?

Calculating your cash burn rate is pretty simple, involving a relatively straightforward formula.

You can choose between two different kinds of burn rates: your current burn rate, calculating how much you spent as a business in the previous month, and your average monthly burn rate, where you take that burn rate and average it out over, say, 12 months.

Those formulas are calculated like this:

• Cash balance in prior month - cash balance in current month = Current Burn Rate
• (Cash balance 12 months ago - cash balance now) divided by 12 = Average Monthly Burn Rate

So for example, if your business has $200,000 in cash reserves now and had $250,000 a month ago, the Current Burn Rate is $50,000, and the business would have another four months before it ran 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 Burn Rate of $16,667 and will run out of cash in another 12 months.

Now, if you're looking at closing your doors entirely for the next couple months due to the virus, the calculation is a little bit different because you will be pulling in far less revenue.

In this case, you need to make an estimate: write down how much monthly revenue you believe you can pull in during this time period, assuming it is greater than zero, and come up with an estimate of how much you could cut your monthly expenses. The difference will be your monthly burn rate.

So if, say, you're a restaurant that is closing its doors and only doing delivery, and you expect monthly revenues to fall from $100,000 to $10,000 per month, but you think you can cut monthly expenses from $75,000 to $25,000 during this period, your monthly burn rate would be $15,000.

If you had $45,000 of cash on hand, that would give you three months before you would need some sort of loan to stay open.

How can I lower my cash burn rate?

A crisis can present an important opportunity for a business to come up with creative ways to lower costs and position itself financially better off when the crisis ends than when it began.

Here are a few ways you might be able to use this situation to lower your costs:

• Renegotiate with your suppliers: They are going through the crisis as well and understand that their customers are hurting. See if you can come up with a deal where you save money in the short term in exchange for some longer-term incentives on their end.
• Come up with other income sources: As mentioned above, a restaurant can avoid going straight to no revenue by offering some sort of takeout or delivery service during a pandemic. This may not entirely replace sit-down business, but it can help soften the blow.
• Find and eliminate waste: Look for opportunities around the business to cut costs, whether that be making sure the lights are shut off except where lighting is absolutely needed or drastically scaling back discretionary spending. The little things can add up.

Tightening up to survive and stabilize

Calculating your burn rate and making hard decisions to contain and slow it will go a long way to ensure you weather this storm. You can take other actions that look beyond strictly financial concerns to stabilizing your business, your employees, and customers.