Cash management, cash forecasting, and burn rate calculations are frequent concerns for entrepreneurs. One metric we love at CoEfficient is Days-to-Zero. Put simply, if your cash receipts stopped tomorrow, how many days until your business ran out of cash? While we all hope this is worst case scenario and as such, this metric may sound a little simplistic, a few variations on this metric can help you make the right decisions when it comes to cash balance.
Our first step is to answer the question: how should you calculate Days-to-Zero? The simplest calculation is cash balance / (monthly expenses / 30). However, there are quite a few options that should be considered, depending on what you are trying to accomplish. The options fall into two categories: 1) What do you use for your cash #? And 2) Which expenses do you include?
Establishing the right numerator (cash) is pretty straight forward, but depends on your purpose. If this is “company health” metric, then use cash only (it’s a cleaner metric). If you are a startup or in a turn-around situation and your focus is to really know how long your runway is, then you may want to include a portion of AR. Excluding 100% of AR may give you an overly aggressive view as even if revenue stopped some cash receipts would still continue. That said, including 100% isn’t the right answer either – the right solution takes some though and we’ll cover that in a future post.
Establishing the right denominator (average monthly expense rate) requires a little more analysis and insight into what you want from the report and how you plan to manage your business with this data. The simplest metric just includes 100% of cash-based expenses (excluding Depreciation / Amortization expenses). This is sufficient if you are using this metric as a “company health” metric only, but it doesn’t model reality.
To model reality, we need to dig into the cost structure a bit more and divide your expenses into 4 categories:
- COGS – Variable (“If you stop making product, these costs stop by themselves.”)
- COGS – Fixed Variable (E.G. Labor – It’s technically variable, but you need to lay people off once orders stop to achieve costs savings)
- COGS – Fixed (Overhead like rent or other long-term leases that you can’t get out of just because you stop shipping)
- OPEX – Below the line expenses
Based on these four expense types, you can get a more refined Days-to-Zero calculation. As with a many things in life, the middle is probably the best place to be. Here are the different calculations of Days-to-Zero that we find useful with a calculation example from a client:
Using a Days-to-Zero metric in management decisions
Now that you’ve calculated a Days-to-Zero (and preferably incorporated it into your regular weekly or monthly reporting package), how should you use it? What decisions does this metric actually help with?
This will largely depend on what type of company you are. We find it’s a useful metric for 3 different types of companies:
- You are a pre-revenue or early-revenue start up and trying to manage cash burn
- You are cash-flow positive, and trying to set the right level of a cash balance to keep on hand
- Your company is losing money and you need to set the level at which you take increasingly drastic cost-cutting measures
The use (and proper calculation) will depend on which type of company you are managing. We’ll cover more detailed use cases and some examples in our next post on the topic.