The Bill’s Kwik Kleen-up was a business designed to provide home cleaning services to homes in a large residential area where both heads of household worked outside of the home. The owner use large savings to begin his venture. The business became popular quickly and the founder was swamped with orders. He found it necessary to hire two people to help him provide the services . After about four months of operation, with orders continuing to increase, he learned that at the end of the seventh month, he was not able to make the payroll. He had spent money on supplies, gas and other operating expenses without an adequate accounting system. He wasn’t able to secure additional funds, so he scaled back to being the only one in the business and never grew to the great business he hoped for.
This is sometimes referred to as “burn” and is a common problem for new businesses. The funds are not matched with the operations and the use of the funds isn’t controlled. It’s important to set up reliable funds management systems either with an accountant, efficient software or other available money management services to make sure the money is tightly controlled. Understanding the burn phenomena and knowing how to control it is a valuable skill for any business owner. In many cases, entrepreneurs are able to acquire venture capital and it is critical to carefully control finances. Unfortunately, many millions of dollars are lost because of mismanagement resulting in high“burn rates”. According to CB insights,“a large majority of start-ups fail 20 months after raising financing.” It is safe to say, many were not aware of the effects of “burn rates”.
“Burn rate” has been described as the rate at which your company is consuming, or burning, its financing or store of venture capital to support operations in excess of cash flow” according to Rosemary Peavler in “What is “Burn Rate and How it is Calculated?”.
It’s important to separate your gross (total) income from your net (actual or income minus your expenditures) income. For example, Bill wasn’t watching his finances closely enough.
- He began his business with $20,000.000 in savings.
- In his first month, he brought in $2,000.00 in sales. His first month expenses were $1,000.00. He considered this income a success.
- His net income was $1,000.00 because of the expenses.
- He was lucky and brought in $1500.00 in income the second month and bought more supplies, without adequate accounting and began considering hiring extra help. He increased his expenses to $1200.00 for the month. His net income for the month was $200.00.
- His gross income for the third month was $1500.00 but his expenses stayed around $1,000.00. By now his net income was $500.00 for the month and his cash reserves were $21,700.00, making his net income for three months only $1700.00.
- He assumed that the monthly income would continue. He hired two workers at the beginning of the fourth month at a cost of $2400.00 increasing his monthly expenses to $3400.00. In the fourth month, his income was $2,000.00`and required over $1,400.00 from the cash reserves to pay workers and buy supplies leaving around $16,900.00 in reserves for the beginning of the fifth month.
- He burned(took from cash reserves) approximately $2,000.00 each month until there were no more cash reserves. He was using cash reserves without replenishing them. He had a high burn rate. He kept his eyes on the gross income and not the net income. He eventually had scale down to become the sole worker in his business.
You can avoid these mistakes by diligently managing your money. There are several things you can do to help you do this.
First, before you open the doors of your new business, decide what type of accounting system you will use. There are some excellent ones computer programs that you can use, or you should hire an accountant. Commit to regular and precise money management. Clearly separate your actual gross income from you net income. The most important financial action you can take.
Second, design and stick to a clear operating budget. Commitment to the process, designing and sticking to a clear operating budget will be a critical component in your business. Know exactly what the cost of operating your business is and be very knowledgable about where the money goes and where it was generated. Always measure your revenue, gross profit and cash (net profit).
Third, keep at least 6 months of operating expenses in the bank.The reason for this is obvious. It is insurance for a potential slow period. Make it a part of your management strategy to project what you think you will need down the road and how you want to expand. Consider how long it will take you to get to your financial targets and align your marketing plans with your projections.
Fourth, keep a clear focus on reserving funds. Don’t buy things that you can do without. Some people let large sums of money excite them. They buy new and shiny things, go to conferences and trade shows, and basically spend money that they don’t need to spend. Conserve money. Recycle everything you can. Buy used equipment or furniture and look for shops going out of business for the things you need. There are many free services on the internet such as web site builders and plugins. Check for free versions of the business systems you need for your enterprise. Let thriftiness become one of your important Values.
Fifth, concentrate on gaining and retaining customers. Think of innovative and thrifty ways to obtain more customers and devise unique ways to keep them. Good customer relations management will help you do that. Look for affordable CRM (customer relations management) software for your business. For example, it’ll help you remember birthdays and other opportunities to thank your customers and build their commitment to your enterprise.
Become a thrifty, focused and successful entrepreneur.
“A budget is telling your money where to go instead of wondering where it went.” Dave Ramsey