In the present Startup Ecosystem of India as per the different studies on an average over 90% Startups get failed within 5 years of their inception. The highest Startup Failure rate is 63% in the IT industry and 42% to 55% Failure rates are in Manufacturing, Transportation, Retail, Construction, Wholesale, Service, Mining, Education, Health, Agriculture, Finance and Real Estate etc. The Finance and the Real Estate industry are having the lowest startup failure rate of 42%.
There are many reasons behind the startup failures and one of the reason is the Cash Burn issue which creates a severe Cash Crisis before the Startups. In all the startups failure it is estimated that around 29% Startups fails because of the Cash Burn. Cash burn is the rate at which a company spends its cash reserves to fund its operations, measuring how fast a company is using up its available cash i.e. burn rate. The cash burn is a very prominent indicator for a startup company which indicates how long the startup can sustain their business operation in their existing funding. Cash Burn Rate is the pace at which a new company which is not yet generating profit consumes its cash reserves. The Cash Burn rate is being calculated by subtracting the total cash spent per month from the initial cash balance present with the startup. A startup must know through the Cash Burn Rate what is their Financial Health and how much time a startup companies may sustain and continue operating with this Cash Burn Rate.
Types of Cash Burn for a Startup:
There are two types of a Cash Burn for a Startups Company.
Gross Burn: Gross Burn represents the total monthly operating expenses of a Startup Company.
Net Burn: Net Burn measures the difference between cash spent and cash earned by the Startup in a month indicating the net decrease in cash over time.
Following are few of the major reasons behind why startups are facing the Cash Crisis due to the Cash Burn.
Startups Focus on Uncontrolled Growth and not the Profitability:
For Startups the rapid growth of their Startup venture is given more importance. Startups very aggressively spend on the marketing and rapid scale up and expansion of their Startup Venture. Since increasing of turn over is more in focus than the profitability, Startup incurred heavy expenditure. This uncontrolled growth is resulted into the severe Cash Flow problem and this Cash Burn subsequently creates a severe Cash Crisis before the Startup Venture. Due to this it becomes very difficult for the Startups to fulfill their financial responsibilities and obligations towards their stakeholders including the suppliers and employees.
Slow Cash Inflow:
One of the very crucial reason behind the Cash Burn is the inconsistent Cash Inflow and Heavy Cash Outflow. This long sales cycles creates an adverse impact on the working capital and delayed payment in the market which hamper the overall production process due to the unavailability of the Raw Materials. Many a times this resulted into the Bed Debt also for a Startup. Once a Cash Inflow is disturbed it becomes very difficult to regain their cash flow.
High Cash Outflow:
To have a very rapid growth and expansion, startups focus too much on the market penetration and fast expansion which is resulted into too much uncontrolled investment in the marketing, sales, new product development, over hiring, manufacturing , infrastructure development and new technology adoption to increase production. This is resulted into very heavy Cash Outflow.
Over Marketing:
Startups in the beginning heavily rely on the heavy marketing to develop their brand and generate the demand. Now a days media is very expensive and investment on heavy advertisement on various media cost a lot to the Startup which immediately are not converted into the desired sales. This increase in the Cash Outflow and decrease in the Cash Inflow is one of the major reason behind the Cash Burn in a Startup Venture.
Product Development, Innovation, Research and Development:
Product Development, Innovation, R&D is the need of hour for any Startup which may require heavy investment in the Equipment, Instruments and Technology. This creates heavy cash outflow and subsequent cash crisis if the cash inflow will be relatively slow.
Insufficient Cash Reserves:
Inconsistent Cash Flow is resulted into insufficient Cash Reserve and insufficient working capital. This makes startup in a vulnerable situation to face the unexpected expenses or delays in the payment of vendors which disturb their entire supply chain process. This resulted into delayed supply of the demanded products. This Cash Crisis collapses the entire demand supply balance.
Operational Inefficiency and Mismanagement of Fund:
Getting funding for a Startup is not a difficult task however management of fund is the real challenge for any startup. Due the high operational cost, operational inefficiencies, financial mismanagement, high overhead cost, massive expansion, over hiring, over advertising and sales promotion, heavy capital and infrastructural expenditure creates situation of Cash Burn and the draining of the Cash Reserves.
Adverse Macroeconomic Factors:
The entire world economic condition is suffering from the stage of VUCA (Volatility, Uncertainty, Complexity and Ambiguity). Startups cash flow are badly effected by the external factors which are not in their control. These factors are like poor market conditions, unstable investor’s sentiment, volatile international economic trends like present Tariff Policy of the Donald Trump etc. which influences a startup’s cash flow and burn rate, leading to unforeseen challenges.
Unrealistic Forecasting
Many times it is observed that while forecasting the Startups either overestimate the revenue or underestimates the expenses. Sometimes both aspects takes place. In both the situation of unrealistic forecasting the startup may face the shortfall of the cash generating the major road block of its operations. The only solution of such problems is realistic down to earth forecasting without any aggregation.
Decline in Sales and Revenue:
One of the very important reason behind the Cash Burn is poor Cash Inflow and subsequent fall in revenue due to the slow or decline in sale. This insufficient or inconsistent revenue is resulted into an extreme financial pressure on the Startups making them in a very difficult situation to fulfill their liabilities towards the market and their stakeholders. The reason may be the improper sales and marketing effort and non-retention of the customers. Shift in the demand pattern and not timely responding to the changed consumer behaviour is also one of the crucial reason behind the decline in sales.
Poor Pricing Strategy:
Many a times Startups think that if they will keep their price low to the customer or consumer or service user their sale will increase. One should always remember that in the entire distribution process every distribution channel member want sufficient profit margin whether its C&F Agent , Distributor , Stockist / Dealer or Retailer . In absence of sufficient profit margin they are not very much interested to promote the product at the consumer end. It’s a usual practice that product or service reaches from manufacturer to the end user through the distribution channel and not directly. If the price to the end user will be too low the channel partners will also get low profit margin. Very low pricing also adversely affects the profitability of the Startup and sometimes it gives a perception of sub standard product. So before deciding the pricing strategy a proper market research should be done to pre determine that how much price has to be kept for the end users as well as the channel partners in the entire distribution network. Lack of Profit means more Cash Burn and more Cash Crisis.
Lack of Full Proof Budgeting:
Budgeting is an essential element of smooth operational functioning of any startup. Many startups are not skilled enough to make a practical and balanced budget for their startup. Many a times they are not aware of their actual needs and their spending increases due to the improper estimation of required resources. This is the reason they lose control over their spending, shortage of cash and the result is deficit in their budgetary allocations. Regular tracking of the actual spending against the budget may save the startups from such an adverse situation.
Heavy Overhead Cost:
Overhead cost for any startup like rent, utility, electricity bill and equipment etc. are having a significant load in the beginning since the revenue in the starting is too slow and overhead expenses are a regular phenomenon. If the low cash inflow continues for a long time this situation is resulted into the Cash Burn situation.
Lack of Economies of Scale:
In many cases the startups are having low demand and subsequently low production due to which a startup firm loose the benefit of economies of scale. The result is the high per unit cost of production which creates Cash Crisis due to the high cost and low profit.
Heavy Infrastructure Development:
Startup in the beginning invest heavily on the establishment of Office Infrastructure, IT infrastructure, Office Automation, Sophisticated High-Tech instruments, Centrally Airconditioned High-Tech office in the Premium Commercial Loation, Over Capacity Manufacturing and Service infrastructure etc. In return to this the revenue does not come in the same ratio. This resulted into the cash flow problem for a startup and result is the Cash Crisis.
Heavy Hiring:
Since in the initial stage a startup has to do heavy hiring for the establishment and expansion of the venture, it requires lot of investment in the human resource and generates a consistent pressure on the Cash Reserves. Human resource regular investment covers their salary, wages, Provident Fund contribution, Bonus and other Perks etc. along with their travelling and daily work allowance. These variables are very difficult to manage if the Cash Inflow is not proper. This is one of the major factor behind the Cash Burn and Cash Crisis.
Cash Burn For Over Valuation :
Many Startups deliberately do the Cash Burn to create an impression of highly valued company so that the prospective investor may invest more in the company in the greed of very high return. In this process due to the aggressive investment many a times the startups are over valued and subsequently resulted into the ultimate failure of the company.
Miscalculation of Cash Runway
It happens that Startups while spending the cash, miscalculate the Cash Runway i.e. an indicator that how long a startup may continue its operations at the current rate of spending before its cash reserve is exhausted. For any startups which is not yet generating income the startup cash runway is calculated by dividing the total available cash with the startup by the total monthly expenses done by them.
By understanding the above mentioned reasons of Cash Burn a Startup may very well strategies to manage their Cash Reserve and survive in the situation of Cash Crisis by avoiding the Cash Burn conditions.
Blog By : Prof(Dr) Raj Kumar Singh
(Author is an expert of Entrepreneurship & Startup Development)
