Publication number: ELQ-30671-1
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The Good, Bad and Ugly Side of Cash Burn
Detailed overview of cash burn, what it is, why it happens and why it matters.
In this video, Aswath gives an in-depth overview of cash burn rates and what he refers to as "the bonfire of venture capital". This insightful video explores what exactly cash burn is, why it happens what to do about it as an investor and in valuation.
Firstly, Aswath demonstrates how to calculate the amount of free cash flow to the firm based on your company's operating income after tax and its reinvestments for the future. Aswath emphasises the fact that this free cash flow figure can be a negative one, if you are basing it on an operating loss. If this free cash flow to the firm figure is a negative, this is the basis for cash burn.
Next, Aswath demonstrates how you can measure the cash burn rate of your company based on your starting and ending cash balances. Aswath puts this into a real-world business scenario, making the process of calculating cash burn rate incredibly simple to follow.
He also analyses the "cash runway", how this can be calculated and ultimately why it is important. The cash runway shows the period of time you have remaining before your business runs out of cash. Again, Aswath uses a real-world business example to demonstrate how the cash runway can be calculated.
Aswath then analyses the "why?" behind cash burn. This emphasises why cash burn rate calculations are necessary for any business, but especially new business ventures.
Cash flow can, according to Aswath, be good, bad or neutral. He analyses different cases of cash burn and what it looks like when it's benign and how to spot it when it's malignant. He uses his benign valuation of Uber to demonstrate cash flow and cash burn rates in a healthy business. He then changes two inputs in order to show what a malignant cash burn rate looks like. These examples emphasise that both good and bad things can happen with cash burn, and highlight that cash burn has to be managed very carefully.
Cash burn has huge effects and impacts for investors. Aswath highlights the two ways that cash burn rates can affect you as an investor. These are the "dilution effect" and the "capital markets effect". Aswath then shows how these effects work on his model for Uber, making these effects easy to follow and understand.
Aswath then analyses the approach that investors should take to companies with cash burn. This will show you, as an investor, what you need to look out for and be wary of with businesses with cash burn.
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