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The three critical tests of your cash control

Wednesday, 11 January 2012 | By Marc Peskett

Start-up businesses are cash hungry. It takes cash to fund the initial development and ongoing growth of the business.

 

With the initial months, or for innovation businesses, years, of costs and investments returning minimal revenue, it’s important to closely monitor and control your cash burn rate.

 

With this in mind, there are three important cash KPIs to measure:

  • Cash burn rate
  • Cash zero date
  • Cashflow breakeven point

The cash burn rate shows how much cash you’re burning each month and how long your existing cash will last.

 

Using a simple example, if you start your business with $100,000 of investment capital and you’ve spent this after 10 months, your burn rate is $10,000 a month.

 

If you don’t reduce your burn rate, start making money or provide an additional injection of funds into the business before the tenth month, you’ll run out of cash.

 

Cash zero date is based on your cash burn rate and is the date at which your current cash will run out. This provides a worse case scenario if no additional revenue or funds become available.

 

However, it’s important to know and put to good use in your financial management and business decision-making processes.

 

Cashflow breakeven point is the point at which internally generated cash, typically from revenue, covers the cash outflows of the business and the date at which breakeven occurs.

 

You need to make sure you have enough cash to cover outflows until the breakeven point is reached.

 

A shortfall in cash needed to reach breakeven would need to be met by external funding sources.

 

To put these KPIs to good use, here any my top five tips to stay on top of cashflow:

 

1. Prepare forecasts

 

Compare actual results to those forecasts and update them to reflect the reality of your cash position.

 

It’s impossible to consistently predict the future.

    Just think how often economists get it wrong. Therefore it’s essential that forecasts are updated to reflect reality.

     

    2. Assess your cash burn rate, cash zero date and cashflow breakeven point

     

    Ideally, you would estimate this as part of your planning and forecasting, before commencing the business.

      This gives you a head start on allowing for your cash needs. Then as the business operates, assess your burn rate based on actual spending and how that impacts the other two KPIs.

       

      3. Identify your funding gap

       

      Your funding gap is how much cash you will need from external sources to fund the business until it reaches its cashflow breakeven point.

        If you know you’re likely to run out of cash in two and a half months, you’ll be more likely to postpone expenditure that won’t provide a direct and immediate impact on generating revenue and devise a plan to obtain the funds you need to continue building and growing your business.

         

        4. Develop a funding plan to cover the gap

         

        Obtaining additional funds whether through debt, issuing equity or pursuing grants is never instantaneous.

          So having a time sensitive plan to know when you’ll need the funds helps to ensure you start work on securing the source sufficiently early.

           

          If you’ve done your homework during your planning stages, you’ll have a funding plan already and can get on with the process of obtaining the cash you need.

           

          5. Closely monitor actual performance and be prepared to make some hard decisions

           

          If the opportunity is not meeting expectations, it’s better to “fail fast” than throw good money after bad.

            Running a business, particularly a start-up is tough, so it’s important to use valuable and relevant information to your benefit. These three KPIs are just some of the indicators at your disposal.

             

            Marc Peskett is a director of MPR Group a Melbourne based firm that provides business advisory services as well as tax, outsourced accounting, grants support and financial services to fast growing small to medium enterprises. MPR Group is a member of the Proactive Accountants Network. You can follow Marc on Twitter @mpeskett

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