Most businesses are going through a rough period. The worldwide economy has been in a depression or a recession, depending on whom you ask, for many months. Now, finally, some businesses are beginning to see the light at the end of the tunnel. The worst appears to be over. The recovery may come soon. For some businesses, the question is whether the recovery will come soon enough.
From the largest corporation to the smallest individual shop owner the calculation is the same. Some items in the formula may be more complex for a large corporation, but they are fundamentally the same. A large corporation has many accountants to do the calculations, but small shop owner calculates the same formula. Do I have enough coming in or can I cut down on what's going out to keep the business going a little longer? Can I find ways to bring in more money? How can I reduce expenditures even more? If I do these things, how much longer can I keep the business afloat? Will that be long enough? How many months away is the recovery?
If you have been asking yourself these questions, here is a simplified formula to calculate how much longer you can keep the business afloat.
(COH + I) / BR = MO
Where:
COH = Cash On Hand
I = Income from all sources
BR = monthly Burn Rate
MO = remaining Months of Operation
Start with your COH, or Cash on Hand. This includes the money in the business' bank accounts, petty cash funds, and any other cash you already have. Add to that any income you realistically expect to receive. This would include payment on outstanding invoices, trade receivables, and cash received from sales. You could also include as income the funds from any additional credit sources you might have available. (If you include credit here, be sure to include the cost of the credit in your Burn Rate below.) Cash plus income is what we have to work with. Our question is, how long will it last?
The other key term in our formula is Burn Rate. This is a way of measuring how quickly our income becomes outgo. You calculate your Burn Rate by adding all your regular and anticipated expenses. Where a shop owner might include rent payments on the store as part of his Burn Rate, a corporation might include mortgage payments on several properties. The shop owner includes the money he pays his nephew to sweep the store every night, while the corporation has to include its payroll, the accrual cost for benefits, and contributions to employee stock purchase programs. Be sure to add all your monthly expenses into your monthly Burn Rate calculation. A good way for a small business to be sure they include all monthly expenses is to go back through the business checkbook for the past several months.
You need to add to the monthly Burn rate calculation a portion of any longer-term expenses. For instance, if you pay one of your suppliers quarterly, be sure to add one third of the expected quarterly payment to your monthly Burn Rate. If your tax assessment is due every six months, you need to add 1/6 of the tax payment to your monthly Burn Rate.
So to determine how many more months you can stay in business you divide your cash plus income by your monthly Burn Rate. If you have $1500 in the bank and expect to receive $500 each month you can expect to stay in business for three more months if your Burn Rate is $1000 per month. Similarly the corporation with a line of credit of $500,000 that has a Burn Rate of $300,000 per month and expects sales of $200,000 per month will survive less than four months.
Tips and Tricks
Obviously, you want to do everything you can to increase your income and to decrease your outgo. A small business owner frequently can take advantage of discounts on invoices for prompt payment, usually upon receipt. Do this during the good times and you will have a little more cash to carry you over some of the rough spots. Similarly, if you make a point of paying invoices on time you may have an additional 60 to 90 day cushion when you really need it before your creditors get nasty. If you are always late paying your invoices, you won't have that cushion.Look for ways to delay payments. United Airlines may negotiate with Boeing to delay delivery of a 747 for a few months. A small business owner can do the same thing on a smaller scale. You could, for example, not purchase the new delivery van for a couple of months. This might mean having to buy new tires for the old van, but it would decrease your Burn Rate. On the other hand, this is not the time to skimp on safety or preventive measures. If you decide not to purchase new tires and the delivery van has a blowout on the freeway, the towing and repair bill is likely to exceed what you would have spent for new tires.
By the way, this works just as well for your personal finances as for a company's finances.
