Burn rate is a measure of how quickly a business is losing, or burning through, money. This is a particularly important metric for startups and venture-backed businesses that might be operating at a loss intentionally, investing more than they’re earning back into the business.
This calculation helps business owners understand how long they can continue to operate at this rate before running out of money, which is called the cash runway.
To calculate your own burn rate, you’ll want to look at your cash balances over a period of time, which are best found on past cash flow statements. If you want to see your burn rate based on last quarter’s spending, for example, input the cash balance you had at the beginning of the quarter, the balance at the end of the quarter, and the number of months (three in this case).
The number provided is the rate at which you are depleting your cash stores each month. If you are making more money than you’re spending, the rate will be negative.
How to Calculate Burn Rate
The calculation for burn rate is straightforward, especially with a cash flow statement on hand. The formula is simply:
Burn Rate = (Starting Balance – Ending Balance) / # Months
Let’s say that your startup has just raised $1 million in funding from investors. Congratulations! You now have the capital you need to make some big investments into your business, whether that means hiring more employees, purchasing an expensive piece of equipment, changing offices, or all three.
As you begin to spend that money, you will start to see your cash balances deplete. As a business, you’ll want to be strategic about what you spend money on and when you might seek more fundraising. So keeping an eye on burn rate will be paramount to making sure your cash reserve isn’t shrinking too quickly.
Let’s say that your business already had $200,000 in the bank before the investor funding was received. This brings your starting cash balance to $1.2 million. After three months, you check back in and see that your cash balance has dropped to $900,000. According to the burn rate formula, your business is losing $100,000 per month.
($1,200,000 – $900,000) / 3 months = $100,000/month
The key to calculating burn rate is to choose a period that is long enough to deliver an accurate average. If you calculate burn rate using data from only one or two months, any fluctuations in spending may give you an inaccurate read on how quickly you are, in fact, spending money.
Using the above example, if your business spent only $50,000 in the first month and $125,000 in each of the following two months, calculating burn rate from the first month alone would give you an unrealistic view of how long your cash would last. For that reason, it’s important to recalculate burn rate each month and to use a long enough time period to ensure accuracy.
There are also variations on the burn rate calculation that can give additional insight into your spending.
Gross burn shows how much your business spends on operating expenses alone. Operating expenses include things like payroll, rent, and taxes. This metric relies on the assumption that your business is not generating a positive cash flow. If the business above, for example, is spending $40,000 per month on salaries, rent, and utilities, the gross burn rate would be $40,000 per month.
Net burn rate takes revenue into account (if your business has generated any), but it still only looks at a single month. To calculate, simply subtract your revenue from all spending and expenses over a month. This will leave you with how much money was lost that month.
Investors may ask specifically for these metrics when deciding whether to invest in your business or not. However, most business owners trying to understand the state of their finances will opt to calculate their overall burn rate instead.
Why Does Burn Rate Matter?
Burn rate is an important metric for both startups and established companies to measure on a regular basis, though their reasons for reviewing it may not be the same. Startups focused on putting investor money to good use don’t share the same concerns around burn rate as established companies or small businesses worrying about staying afloat.
Startups and Burn Rate
Startups, especially those in high-growth industries, often take years to become profitable on their own, relying instead on venture-backed investments to fuel their development and growth. Many startups will go through several rounds of funding on their road to profitability, often receiving a larger sum of money with each successful round.
In between rounds, they’ll start spending that money on initiatives that will (hopefully) yield profit down the line. How they choose to spend the money and how much they spend varies from startup to startup. However, future investors will be watching closely.
Burn rate signals to investors whether a business is too free or too constrained with their spending. Spending too slowly may raise red flags that the business is afraid to invest aggressively or that growth may not happen as quickly as they’d prefer. Spending too quickly, on the other hand, may make investors question leadership’s ability to properly manage funds.
In addition to investor optics, burn rate can help startups plan ahead for when they’ll need to seek new funding. The average time between rounds of funding tends to be 12-18 months, meaning that (in most cases) each new round should sustain a startup for at least 1-2 years. Keep in mind that it can also take some startups 6-9 months to secure new funding. So once funding is secured, there may only be a few months before startups need to hit the fundraising trail again. Burn rate will help you know when it’s time to get back out there.
Established Businesses and Burn Rate
Those businesses not in the process of seeking venture capital funding should still monitor burn rate if they find themselves operating at a loss. Burn rate, along with cash runway, can help these businesses understand how long they can continue to operate at a loss before shutting their doors. In other words, it sets the stakes for how urgently they need to find a solution and increase revenue.
Improving Burn Rate Metrics
If you’re a startup and realize that your burn rate is too high or if you’re a small business trying to rebound after a few tough months, here are a few steps to take to help decrease your burn rate (or eliminate it altogether).
- Study your financial reports. Gather the last few months’ financial reports and spend some time digesting them. Did any changes in revenue or spending occur? Can you pinpoint when they happened and in what area of the business? Your financial reports can reveal a great deal when reviewed closely.
- Reduce costs. For startups especially, this is the most useful lever to pull to adjust burn rate. Review your COGS and operating expenses closely to look for extraneous spending that could be cut.
- Sell assets. Take a close look at your assets. Is there anything that could be liquidated for additional cash? For instance, if you have three delivery vans but really only need two, consider selling the third.
Increase revenue. For small and well-established businesses, finding ways to increase revenue will be a better long-term fix than simply reducing costs. Examine your marketing and sales processes and test out some new ideas before resorting to selling assets or cutting expenses.
Using Burn Rate to Determine Your Cash Runway
Burn rate is a key factor in determining cash runway, or how long your business can continue to operate at that rate before hitting zero dollars in the bank.
The formula for cash runway is simply:
Cash Runway = Current Cash Balance / Burn Rate
Looking back at our previous example, if our startup has $900,000 in cash remaining and has a burn rate of $100,000/month, we’ve got 9 months of runway—or nine months until we run out of cash.
$900,000/$100,000 = 9
Since most startups are dealing with larger sums of money, let’s imagine a larger-scale example as well. Startup, Inc. has just raised $10 million, bringing their cash balance to $11.5 million overall. Over the next three months, they go on to lose $250,000, $300,000, and $275,000, respectively.
In order to calculate Startup, Inc’s burn rate, we would first need to calculate their total losses ($250,000 + $300,000 + $275,000), which gives us $825,000. This means that, after three months, they have $10,675,000 left in the bank.
Next, we’ll insert the relevant numbers into our burn rate formula.
(Beginning Balance – Ending Balance) / # of Months
($11,500,000 – $10,675,000) / 3 = $275,000
Knowing that Startup, Inc. is spending $275,000 per month, we can now calculate their cash runway.
Current Cash Balance / Burn Rate
$10,675,000 / $275,000 = 38.81 months
At the rate they are spending, Startup, Inc. has a cash runway of just under 39 months. Knowing that most startups will seek more funding within a year, this number should signal to leadership that they should probably increase spending and invest in some initiatives to help drive them toward profitability.
Burn rate and cash runway go hand-in-hand for startups. Together, these metrics give businesses a clear understanding of how quickly they are losing money, how long they can continue to do so, and whether they need to make adjustments to hit their goals.
Knowing Your Burn Rate
For any business that is not generating a profit, calculating burn rate and cash runway is a valuable exercise. However, for startups with an eye on the future and a desire to seek more funding, knowing your burn rate is essential to establishing your spending strategy and reaching your goals.
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Insert your company cash balances from the previous three months to calculate your burn rate and cash runway.