If you’re an entrepreneur or business owner, you know that cash is important. But, do you know how to measure the amount of cash your business is burning through every month?
Many startups track their cash burn rate to determine how long the business can survive without raising additional funds. It can be helpful to understand the burn rate if you work in finance or are a team member for a new startup.
In this blog, we explore the cash burn rate, demonstrate its importance, and provide the formulas for determining it.
Table of contents
- What is the cash burn rate?
- How to calculate cash burn rate?
- Types of cash burn rates
- Top 4 reasons why should you measure burn rate?
- 4 Tips to improve cash burn rate metrics
- Final thoughts
What is the cash burn rate?
The cash burn rate determines how quickly a business spends its cash reserves over time.
Using the burn rate, you can calculate how much time your company has left to operate before running out of cash, which is also referred to as the cash runway.
To survive, a company needs to turn a positive cash flow or raise funding from outside investors before it runs out of money.
As it can take many years for an unprofitable company to start making a profit,
The burn rate gives you an idea of how long it will take to achieve your goals.
How to calculate cash burn rate?
To calculate the cash burn rate, you typically subtract your total cash at the end of a period from your total cash at the beginning of that period. Then divide that difference by the number of months in the period.
For example, if you started with £50,000 and ended with £40,000 over a 3-month period, your monthly cash burn rate would be (£50,000 – £40,000) / 3 = £3,333. This indicates how much cash your business is using each month to cover expenses.
Types of cash burn rates
Gross Burn
The gross burn rate is the total cash you spend each month.
This measurement uses balance sheet, cash flow statement, and P&l reports to calculate a company’s burn accurately.
The gross burn rate clearly shows how much cash you spend monthly. It’s also an economic measure that all investors, venture capitalists, and board members want access to.
| Gross burn rate = Total operating expenses |
Net Burn
Your net burn rate is the total money you lose each month. It takes into account both monthly income, cost of goods sold (COGS), and overall expenses. This involves proceeds from the cost of sales and revenue.
Net burn on your monthly P&L statement is equivalent to net operating income, excluding the impact of any non-cash items like depreciation and accrual accounting adjustments. This cash burn rate offers the most extensive burn perspective by weighing income and revenue against expenses.
Investors and board members favour this burn rate since it utilises accrual accounting. As a result, the computation will be more reliable and appropriately aligned with the rest of your financial records.
| Net burn rate = Revenues – Operational Expenses – COGS |
It is typically reported in monthly terms.
Top 4 reasons why should you measure the burn rate?
- Identifying underinvestment
A high burn rate is sometimes a good thing. Investors’ money should be used wisely.
Suppose you’re not using the capital you’ve raised, just sitting in your business bank account. In that case, you could be falling behind rivals who will invest in advertising, product development and sales to gain greater market share.
Keeping an eye on your burn rate and allocating funds wisely for expansion is crucial.
- Impacts your capacity to raise capital
A high burn rate can make it more difficult to fundraise. If an investor notices that the business is running out of funds, investing becomes riskier. If you do secure funding, it’ll probably come on worse terms.
Investors have typically been ready to fund the operations of high-growth, loss-making businesses during prosperous economic times. However, in a downturn, investors are less prepared to pay for cash burn and will expect firms to show profitability sooner.
- Strategic Planning
Burn rate analysis provides strategic scheduling and allocation of resources. It assists companies in assessing the return on their investment, pinpointing areas for cost-cutting or optimisation, and reallocating resources to projects that maximise profits.
This allows businesses to optimise efficiency and match resources with strategic objectives.
- Risk mitigation
High burn rates risk enterprises, particularly startups and early-stage companies.
Companies can proactively detect and solve financial issues by measuring burn rates before they escalate.
It allows management to broaden the runway, secure additional funding, or modify the company’s model if necessary to reduce risks and ensure long-term viability.
4 Tips to improve cash burn rate metrics
1. Understanding Financial Statements
Collect the accounting records from the past couple of months and take some time to comprehend them. Check to determine if spending or revenue has changed. Try to narrow down what happened and to which part of the business. Financial reports indicate significant quantities of data when understood accordingly.
2. Minimise costs
This step is the most effective for modifying the burn rate, particularly for new businesses. Check the cost of products sold and operating expenses to identify unnecessary expenditures that can be eliminated.
3. Sell assets
Review your wealth to see if there are assets that can be liquidated to boost the cash on hand, thus raising the burn rate.
4. Increase revenue
Finding methods to improve revenue is a more sustainable solution rather than solely reducing costs.
Final thoughts
Understanding and calculating the cash burn rate is crucial for businesses, especially startups and those in volatile industries. It provides valuable insights into financial health and sustainability.
Remember, a positive cash burn rate isn’t necessarily bad if it’s part of a well-thought-out growth strategy. However, consistently burning cash without a clear path to profitability can spell trouble.
