SLATE. All you wanted to know about cash burn rate

When someone who has invested a billion dollars in Indian start-ups issues a warning, it’s time to sit up and take notice. Nikesh Arora, President and COO of SoftBank, recently asked Indian e-commerce players to stop the ‘cash burn’ and focus on customers instead. Japanese SoftBank has been one of the biggest investors in Indian start-ups, having funded ventures such as Snapdeal, Ola Cabs, Housing.com and Oyo Rooms.

Cash burn is the rate at which a company uses up its capital to run its day-to-day operations. ‘Cash burn rate’ is a metric that measures how the company’s net cash position has changed over a time period, usually in a month. The burn rate helps evaluate how quickly a company will run out of capital, if its revenues and expenses continue to grow at the present rate.

A start-up with a higher cash burn rate will be knocking more frequently at the doors of its angel, venture capital or private equity investors for money to keep its operations going. But why should any company use up more cash than it earns as revenue? Isn’t it meant to run the business to make a profit? In the case of many e-commerce startups in India, the answer is ‘No’.

Valuations for e-commerce players are today decided on the total value of sales (known by the fancy term Gross merchandise Volume or GMV) that they route through their portals. To keep the GMV going, players spend heavily on advertising their brand, fund discounts on products out of their pocket, have liberal return and exchange policies and offer free shipping to far-flung corners.

All this costs money. These start-ups hope they will be able to turn a profit once they ramp up their market share to levels that their rivals can’t replicate.

As long as the player does manage to keep ahead in this race, VCs are often willing to put with a high cash burn rate. But if customer acquisition or growth slows despite cash burn, funding dries up. Today, with hundreds of consumer-facing start-ups vying for funding, the ones with a high cash burn rate and poor traction can shut shop quickly.

Arora’s comment also shows that large institutional investors may be growing weary of this ‘cash burn’ model of growth. They would like to see start-ups get customers through less expensive, if traditional, means such as good customer service, a superior products and a truly differentiated idea or brand.

Start-ups are big hirers of fresh graduates today. So if you’re applying to a start-up, look for data on its cash burn rate, for that will tell you whether the job you’re angling for is a sustainable proposition. A recent news report said that start-up star Housing.com was laying off over a 100 employees to cut costs and streamline operations in order to reduce cash burn. TaxiForSure, a cab aggregator, was forced to sell out to its competitor Ola Cabs, as its cash burn got too hot to handle.

If you’re a frequent shopper at e-commerce portals, you should know that the discounts and goodies on offer which lead to a high cash burn, will not last forever. If institutional investors refuse to funnel new cash into these ventures or ask them to use their cash more wisely, the discounts and freebies to customers like you could quickly disappear.

Big discounts on everything from taxi rides to solitaires may be cool for consumers. But that can last only as long as someone else funds the cash burn.

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