Burn Rate

Definition
 

The burn rate is the rate at which a startup spends its cash reserves.

Description

Burn rate enables startups and enterprises to compare their monthly expenses to revenue, allowing them to plan for sustainability, make wise financial decisions, and efficiently manage cash flow. It's an essential statistic for preserving the company's financial stability and ensuring its long-term existence.
 

It is computed by dividing the startup's total cash on hand by the anticipated number of months of operation. 

Startup Burn Rate Calculator:  Startup’s total cash on hand

   Anticipated months of operations

A startup's burn rate, for instance, would be $83,333 per month if it had $1 million in capital reserves and intended to last for 12 months.

The burn rate is a crucial measure for startups to monitor since it can tell them how long they can survive before needing to raise more capital. The startup may run out of money before achieving its objectives if the burn rate is too high.

How to calculate the burn rate?
 

Net burn and gross burn are the two different types of burn rates.

The total amount of operating expenditures that a business incurs each month is simply referred to as its gross burn rate and is expressed as:

Gross Burn Rate x Monthly Operating Costs

Net Burn Rate = (Monthly Revenue - Cost of Goods Sold) - Gross Burn Rate 

Tips to manage Burn Rate

Here are some tips to manage burn rate:

Set reasonable objectives: 

It's crucial to estimate your financial requirements realistically when beginning a firm. Avoid splurging excessively on non-essential items.

Spend less: 

When you own a business, there are several ways to cut costs. You can be creative with your marketing, bargain with merchants for savings, and use free or inexpensive tools and resources.

Prioritise revenue: 

Increasing your revenue is the best approach to lower your burn rate. This entails putting a priority on making sales of your goods and services and creating cash flow.

Raise capital: 

You might need to do this if your burn rate is too high. This may be an effective strategy to obtain the funding you require for business growth.

 

Things That Can Affect Startup’s Burn Rate

These are the things that can affect startups:

• The team size of the startup: A bigger team will often burn through resources more quickly than a smaller team.
• Costs associated with the startup's goods or services: The burn rate will be larger if the startup's goods or services cost a lot to make or provide.
• The firm's marketing and sales efforts: The burn rate will be higher if the startup is spending a lot of money on marketing and sales.

Example:
 

ABC Tech Solutions is a startup in the software-as-a-service (SaaS) industry.

Scenario: In a given month, ABC Tech Solutions had total operating expenses of $50,000, which included salaries, rent, utilities, marketing costs, and other operational expenses. During the same month, they generated $30,000 in monthly recurring revenue (MRR) from their SaaS subscriptions and the cost of goods sold $5,000/-

Calculation: To calculate the net burn rate, subtract the monthly revenue from the monthly expenses.

• Net Burn Rate = Total Operating Expenses - Monthly Revenue
• Net Burn Rate = $50,000 - $30,000
• Cost of Goods Sold= $5,000
• Net Burn Rate = $15,000

Interpretation: In this scenario, ABC Tech Solutions had a net burn rate of $20,000 for the month. This means they were spending $20,000 more than they earned in revenue during that period. The company needs to monitor and manage this burn rate to ensure they have sufficient runway (cash reserves) to sustain their operations while working towards profitability.

FAQ

What is the monthly burn rate for business?

The monthly burn rate is when a company consumes its cash reserves or financing to cover its operating expenses, such as salaries, rent, utilities, and other monthly costs.

What is the cash burn rate formula?

The cash burn rate formula calculates how much a company spends or " burns" over a specific period, typically every month. The formula is as follows:

Cash Burn Rate = Beginning Cash Balance - Ending Cash Balance

• Beginning Cash Balance: The company's cash at the start of the period.
• Ending Cash Balance: The amount of cash the company has at the end of the period.

Why is monitoring the monthly burn rate important for startups?

Monitoring the monthly burn rate is crucial for startups to ensure they have enough runway (cash reserves) to sustain their operations. It helps them manage cash flow, plan for financing needs, and work toward profitability.

How is the monthly burn rate calculated?

To calculate the monthly burn rate, subtract the monthly revenue from the total monthly operating expenses. The result represents the net cash outflow for that month.

What does a negative monthly burn rate indicate?

A negative burn rate means a company generates more revenue than it spends in a month. This positive sign indicates that the company is operating with a surplus.