“There’s no shame in being broke! But it is a shame not to know when you are broke! ” This is the quote from a speaker on financial planning that I attended before I started. A good financial overview is the elementary prerequisite for a successful freelance job. Therefore you should always keep an eye on your cash burn rate. In this article I will show you what the cash burn rate means and how you calculate it.
The cash burn rate shows you as a prospective freelancer how long you can continue your freelance work until all your financial resources are used up. The higher the calculated value is, the more solidly your freelance activity is secured.
How is the cash burn rate calculated?
You calculate the cash burn rate if your expenses are higher than your income. This is almost always the case when starting a freelance activity. High fixed costs are offset by comparatively low turnover in the start-up phase. I would like to explain the calculation with the following example:
You start your freelance work. For this you have saved 12,000 EUR as a financial cushion. Your running costs amount to 1.800 EUR per month.
Because it is a new foundation, the monthly costs of 1,800 EUR are only offset by income of 400 EUR. This results in a monthly minus of 1400 EUR.
Now we calculate the cash burn rate to see when the financial cushion is used up:
The general formula:
CBR = Reserves / (expenditure – income)
In our example:
CBR = 12,000 EUR / (1800 EUR – 400 EUR)
CBR = 8.571 months
In this example we see that it takes about 8.5 months until the financial cushion for the freelance work is used up. In order to avert or delay the bankruptcy, income must be increased, expenses reduced or the starting capital increased.
If you start your freelance work because you are working on a larger customer project where you are paid out after 12 months, you can see from the CBR (8.57) that your reserves are not yet sufficient. In this case the CBR should be at least 12. So you would be forced to file for bankruptcy even before the project is finished. By calculating the CBR you now know that you need more starting capital or that you have to reduce expenses or increase income during the project phase.
The cash burn rate for established freelancers
Even as an established freelancer I often use CBR to calculate scenarios. examples: How long do my reserves last if a large customer is lost? Can I afford an employee and the associated monthly fixed costs? How long will my financial cushion last if I make a certain investment in my freelance work?
For me, the cash burn rate is more than just a simple key figure. I can use it to determine whether a start-up is promising and develop strategies for my freelance work. At the same time, a regular calculation of the cash burn rate protects me from falling into debt. Which financial key figure do you use for your freelance activity? I am curious about your comments!