By: Kelcee Blue – Director | Strategic Finance and FP&A
One in five startups will fail in their first year. Half of them will fail within five years. The hard truth is that starting a business is an uphill battle, and many never make it to their break-even point.
There are thousands of great ideas out there, really interesting ideas that attract investor interest by the droves. But having a good idea alone isn’t enough to get their cash. As a startup, you have to prove viability by showing a plan to get to cash flow break-even before your money runs out.
Sounds simple on paper, but what if the economic climate is tough? What if your efforts to raise capital fall short–and even though you’ve been at it for several years–you’re still not achieving venture-style growth?
Take a step back and make a plan to get to cash flow break-even.
What Does It Mean to Break-Even?
Breakeven means getting to a point where your business can sustain itself without additional loans or capital required for survival. In the simplest terms:
Cash In >/= Cash Out
The understanding of cash flow management is complicated by the use of different definitions or uses of the term “cash burn.” You may choose to target net cash break even or operating cash break even, depending on your situation. The important thing is that you are aligned with all stakeholders (investors, board, etc.) and that you understand the impact and consequences of each.
|Gross cash burn
|Total cash outflows in a given period (total of what you spent)
|Net cash burn
|Total cash inflows – total cash outflows (what you lost in a month after accounting for income and spend)
|Operating cash burn
|Total cash inflows – operating expenses (typically the same as net cash burn excluding financing and investing activities like loan draws, loan repayments, etc.). This definition focuses on what is controllable by the operations of the business.
Step One: Understand Your Current Cash Burn Pattern
Understanding cash burn can be even more complicated because cash flow isn’t always the same from month to month. Significant seasonal peaks or lulls experienced in some industries add variability. Business or industry norms, like making large payments to vendors or employees in certain months of the year, also add variability.
However your business spends cash, recognize the seasonal patterns and use that data to more effectively plan for cash runway.
Step Two: Work Out Your Time Frame
How much time do you have to work with? This could be a date set by an external stakeholder, or it could be the point at which you exhaust your runway (current cash holdings / monthly net cash burn).
For example, if your company chose to target operating cash burn and had $150,000 in monthly operating expenses and your monthly revenue is $80,000, your monthly cash burn would be $70,000. ($150,000 – $80,000 = $70,000).
Now, let’s say you had $700,000 in cash reserves. This would make your company’s time to break even equal to 10 months. ($700,000 / $70,000 = 10)
Step Three: Identify a Strategy for Closing the Gap
A good strategy begins with a clear understanding of your goal. Break-even can only happen if you:
- Decrease cash out
- Increase cash in
It is important to be realistic about how much of the gap can be closed by increasing cash in. Every company will eventually reach a point of diminishing returns with scale. While it can be uncomfortable to make cuts, it is often necessary when getting to break even in a condensed time frame.
The sooner you make cuts, the bigger the impact will be on your runway. The biggest mistake that startups make is holding out hope that the big boom is coming–that revenue will increase without a clear plan.
Strategy 1: Decrease Cash Out
In order to decrease cash out, you will need to evaluate spending and cut nonessential costs. Labor is often the biggest cost, which means it is your biggest lever to pull. However, layoffs aren’t the only step you can take to curb spending. You might also look at vendor-related costs, material or inventory costs, freight costs, and marketing expenses to trim the fat.
Review headcount by team. Consider reducing staff in any areas that aren’t driving your revenue or keeping the lights on. When cash is tight, it is not the time to invest in research and development or minor product enhancements.
Now is a good time to consider where additional overhead savings can come from. Could you outsource some or all of your current full-time employees at a lower cost? Would you save money off-shoring or making fractional commitments in some areas?
As you evaluate which positions to cut and how much of your workforce needs to go, be mindful that terminations may come with additional costs. Paid Time Off (PTO) payout or severance can actually cost more in terms of cash in the short run.
Evaluating Vendor Spend
How much money are you spending on vendor-related costs? Could you save money by switching to another vendor? Reviewing this data can feel overwhelming. To make it manageable, ask your bookkeeper for a list of ‘spend by vendor’, ordered by materiality.
Start with the 80/20 rule. If 80% of spending comes from 20% of your vendors, focus your efforts on the top 20%. You want to act immediately, terminating anything that you can live without or temporarily reduce until you get your cash burn under control.
As you evaluate your essential services, be careful not to make the mistake of assuming it is all or nothing,–or that there are no opportunities to improve spending. Seek external support with specialized expertise to improve efficiency on larger, more complicated expenses like hosting, warehouses, or facilities management.
Strategy #2: Increase Cash In
The other side of the coin is to increase cash in. This involves optimizing your marketing efforts, dialing in on customer engagement, and reevaluating your pricing strategies.
Optimize Your Marketing Efforts
Are all channels driving profitable revenue? In other words, is the revenue that each channel generates more than the cost of that channel? Focus on marketing attribution by channel and begin tracking revenue versus expenses at a granular level. You want to better understand if investing more in a certain channel will drive more profitability. (Hint: the answer isn’t always yes).
- Implement data tracking by channel
- Quantity of leads
- Lead conversion
- LTV of leads converted
- Regularly review performance by channel
- Adjust marketing spending to align with highest highest-performing channel
Scrutinize Your Churn Rate
Churn is the rate at which customers unsubscribe or discontinue using a product. Especially in technology-related startups, like SaaS companies, this is an important metric to understand the cost of acquiring and keeping customers in relation to your marketing strategies and product offerings.
You can improve churn rates by:
- Improving Customer Engagement
- Improving Product Design/Usability
- Offering a Loyalty Program
- Revamping Your Onboarding Process
Engage Your Existing Customer Base
Your existing customers are truly your biggest opportunity to boost revenue. Look for immediate opportunities to upsell or cross-sell to people who are already interested in your product or service. This low-hanging fruit can be much more cost-effective than attracting and acquiring brand new customers.
Consider trying these tactics:
- Personalize Communications
- Offer Exclusive Discounts
- Improve Customer Service Metrics
- Invest in Customer Education
Reevaluate Product/Service Pricing Strategies
Finally, did you know that how much you sell your product or service for is a strategy that is potentially helping or hurting your cash flow? There are a few different approaches for pricing. Consider ways to offer variety, like adding a free trial to get customers interested or utilizing a subscription model to create recurring revenue.
Other Strategies & Best Practices to Reach Cash Flow Break-Even
Improving operational efficiency, negotiating favorable contract terms, and staying on top of the administrative side of your business all impact your burn rate.
1. Evaluate your inventory levels. Look for opportunities to adjust reorder levels or liquidate aging inventory on hand.
2. Review your commercial leases, consolidate space and sublease extra square footage where possible. If you are using multiple warehouses or offices, get honest about what you really need and get rid of the rest.
3. Get to work collecting outstanding receivables. If needed, dedicate resources to collect whatever is owed to you from existing customers. These are sales that have already been made and costs that you have already incurred but have not yet been paid for.
4. Negotiate better payment terms with vendors and customers where possible. Move vendors to Net15 or Net30 terms instead of cash on receipt and opt for monthly or quarterly commitments instead of annual or multi-year payments. For customers, do the opposite. Push for cash on receipt payments with long-term commitments.
Getting to cash flow break-even takes a lot of grit and discipline but is very possible with the right plan. Your business will emerge stronger and more efficient, and you will be more resilient to changing macroeconomic conditions.
Tackling this project can be difficult while continuing to run the business. The often-quoted piece of business wisdom compares organizational change to the equivalent of “changing out the engine on a 747 while keeping the plane in the air”.
Embarc can be your partner in supporting you on a path to break even while you keep the plane flying.
At Embarc, we bring deep expertise in financial management, planning, and analysis to support startup sustainability. Our approach is different. We have found that no single person can effectively undertake the complexities of FP&A–and do it well.
That’s why we provide a team-based approach to ensure our clients receive dedicated attention and knowledgeable expertise from every angle. We provide extensive experience ranging from startups to public companies with experience in growth, turnaround, restructuring, and M&A.