Burn rate is a measure of how long your company can operate until it runs out of money. This is an important metric for companies that are intentionally operating at a loss, like startups.
Startups invest heavily in building their products in the beginning, usually using investor money to do so. Burn rate is an important metric for them to keep track of because it lets them know how quickly they are spending that investor money and when they’ll run out of it.
The same logic applies for small businesses that were started off with an initial influx of capital, like the owner’s personal savings or a bank loan.
Calculating your burn rate regularly allows you to create a plan for what to do with your remaining cash. If you’re a startup seeking funding, this will help you to determine when you’ll need to get back on the fundraising trail—and what kind of metrics you’ll need to hit by then to remain attractive to investors. Small business owners, on the other hand, may be more focused on driving sales immediately to increase their cash reserves.
How to Calculate Burn Rate
The formula for calculating burn rate is pretty simple, especially if you have a cash flow statement handy. Here’s what you need:
Burn Rate = (Starting Balance – Ending Balance) / # Months
For a defined length of time, subtract your ending cash balance from your beginning cash balance and divide that number by the number of months in the selected period of time. That final answer equals your cash burn per month.
For example, if you started the year with $1,000,000 in cash and ended the first quarter with $400,000, your burn rate would be $200,000.
In other words, you’re currently spending approximately $200,000 per month, meaning you’ve got about 2 months of cash left if you keep going at this rate.
What About Revenue?
Burn rate gets a little more complicated if your business is generating revenue, but not much. If you want to get more granular and see how your revenue affects your burn rate, you can perform two separate calculations: gross burn and net burn.
Gross Burn: Your gross burn is the total amount you’re spending each month on expenses.
Net Burn: Your net burn shows you how much you are losing overall after taking revenue into account.
Using the same basic example, let’s say that your business spent $600,000 in Q1 on office spaces, payroll, COGS, etc. But your sales team brought in $450,000 in revenue. Your gross burn would be $600,000, but your net burn would be only $150,000.
If your business is in the phase where you expect it to start generating profits soon, net burn is an important metric to keep an eye on to make sure that it moves closer to zero as time goes by.