There is a useful diagram that shows the change in cash in a typical venture: As

Question

There is a useful diagram that shows the change in cash in a typical venture:

As you can see, the cash balances go up by the amount raised in each round of financing. Then, the company spends cash to produce information – they choose a burn rate by deciding how much to spend, given any incoming cash from customers. The slope of each of the declining lines in the diagram represents the burn rate – the amount of cash consumed per unit of time. If you extend the lines to the $0 cash balance axis, you can identify the fume date.

This example company plans to raise four rounds of financing after launch. What factors influence how much the company raises and how much they spend each period?

FINANCING ROUNDS, BURN RATES AND FUME DATES 15 13 RAISE NEW CAPITAL BURN RATE CASH CONSUMEDATIME FUME DATEE $0 CASH BALANCE -1 0 3 69 12 15 1821 24 27 30 33 36 CASH BALANCE

Explanation / Answer

The very first thing that we should note here is the slope of each line. The more steep the line is, higher is its slope which means the burn rate is higher for that particular period. So here we can see that line has least rate in first phase and highest in the third phase.

Now what we are seeing in the above graph can be considered as 4 phases for a business. For the first phase is the seed/development/startup stage. In this stage more attention is towards setting up a business and whatever cash the firm has is either the owner's equity or a little bit of financing that they might have got approved from any entity which is ready to finance them. Now here the slope is also very less, and it is because most of the attention is towards managing sales expectations, accounting management, planning how to proceed. Here assets are quite fewer and hence not much of the cash is consumed. There is only a single office where most of the work is carried out. So the capital requirement is less and spending is slow here.

In this second phase which we can also call the growth phase, the amount raised is somewhat higher and burn rate is higher than 1st one. But here most of the spending go into maintaining competition, you are not the king of market!!.. So you need to manage your revenues, managing accounts and expanding workforce. Operating expenses are higher in this stage which consume a lot of cash. Expanding customer base further increases the credit sales as well. Also in this stage the amount rasied is somewhat higher due to potential returns from your business that these investors might get. Few banks might provide loans as well. And also even after consuming cash the fume date is quite far which was very close in 1st stage.

In third phase or the expansion/ rapid growth phase, we see highest burn rate. Cash is consumed very rapidly but still the fume date is quite far to be reached. Even more amount can be raised as investors are assured for the returns that they are going to get from your business and also for expansion purposes amount required is also very high as you are entering an entirely new market and setting up a whole business there would require a lot of investment into that. Capital can also be raised through equity in this stage. Exapnding business consumes cash very fast and so is this stage. Also company owns a lot many assets now and cash conversion cycle is also at its peak here.

In fourth or the maturity phase, we see that slope has again decreased, cash balance is quite high and amount is raised either for exapnding business a little more or maintaing the competetion and try to become a monopolist. Expansion still continues and also there are a few exit startegies being formed like mergers or joint ventures. This requires capital to be raised. Cash balance is higher to meet the other needs and to maintain liquidity in the firm. Also capital is very easily available at this stage.

So these are a few corporate factors that affect the cash balances at each stage and accordingly firms require financing at different stages of their business.

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