Without a doubt, the burn rate metric is one of the most essential metrics for businesses and especially so for startups that aren’t generating money just yet.
In fact, by tracking your burn rate, you can better manage your company’s finances, reduce unnecessary costs, and prevent your business from going bankrupt.
Calculating your company’s burn rate, however, can seem a bit difficult if you don’t exactly know how to do it.
So, in this article, we will cover everything you need to know about calculating your company’s burn rate, including:
- What is Burn Rate?
- How to Calculate Burn Rate?
- Real-Life Burn Rate Example
- Why Burn Rate is Important
- How to Reduce Burn Rate
- What’s a Typical Startup Burn Rate?
- My Burn Rate is $100k, Is That Good or Bad?
What is Burn Rate?
Essentially, the burn rate measures how much money your business spends monthly to cover all expenses.
Or, put differently, the burn rate shows how fast your company is going through its capital.
For this reason, the burn rate also helps you to estimate your company’s cash runway, which shows how long your business can operate before it runs out of cash.
So, if your company’s capital is, for example, $500,000, having a burn rate of $100,000 per month means that you can expect to go through your capital in 5 months.
What is a Good Burn Rate?
A good burn rate is one where you can afford to upkeep for at least 12 months at that same rate.
This means that if you’re burning $500,000 per month, you should have a cash balance of at least $6m in the bank today to cover those losses for the next year.
How to Calculate Burn Rate?
Although calculating your company’s burn rate is fairly simple, you should know that there are, in fact, two types of burn rates that you need to calculate – gross burn rate and net burn rate.
Now, here’s how you can calculate your company’s burn rate.
Burn Rate Formula
First, let’s see how you can calculate your company’s gross burn rate.
The formula is simple:
Gross burn rate = total monthly spendings
By calculating your company’s gross burn rate, you can find out how much your company spends per month (or any period that you wish to measure) without adding in the revenue.
Now that you know the gross burn rate or your monthly expenses, you can calculate your net burn rate using this formula:
Net burn rate = total monthly revenue – total monthly spendings
Basically, calculating your net burn rate can show you the difference between your monthly cash inflows and outflows.
As such, the more revenue your company generates, the more your net burn rate decreases.
Gross VS Net Burn Rate
To put it simply, gross burn rate measures the total amount of money your company spends in a month.
For this reason, gross burn rate can show you for how long your business could operate if you lost all of your revenue.
So, for example, if your gross burn rate is $500,000 and you have $1 million in your bank account, your business could survive 2 months without generating any revenue.
However, it’s highly unlikely that your company will lose all its revenue – and that’s why calculating your net burn rate can be more useful for your business.
Essentially, net burn rate puts your expenses into perspective by allowing you to see whether you’re spending your money in a way that’s profitable for your company.
So, for example, spending $1 million in a month may look like a lot – however, if you’re generating $3 million in monthly revenue, your business is thriving despite the large expenses.
You should also keep in mind that a negative cash flow isn’t necessarily bad for your business.
If you’re just starting, for example, you need to invest large amounts of money into your business to drive revenue in the future, which increases your burn rate.
In the long run, however, these investments pay off by generating revenue. Nonetheless, it’s important to track how many months your business can survive before it starts generating revenue.
Real-Life Burn Rate Example
Now that you know the two burn rate formulas, let’s see how you’d calculate your company’s burn rate through an example.
Let’s say your company, which has $150,000 in the bank account, spends $5,000 on office rent, $20,000 on salaries, and another $5,000 on server costs.
Here’s how you’d calculate your gross burn rate:
Gross burn rate = $5,000 + $20,000 + $5,000 = $30,000
Once you know your gross burn rate, you can also calculate how long your business can last without any revenue.
Simply divide the total cash your company has by your gross burn rate as such:
$150,000 / $30,000 = 5
Basically, your company could survive 5 months without generating revenue.
Now, let’s say your company generated $50,000 in revenue last month.
In this case, you’d calculate your company’s net burn rate as such:
Net burn rate = $50,000 – $38,000 = $12,000
Why Burn Rate is Important
Calculating and tracking your burn rate is vital to your business – and especially so for young startups.
After all, if you don’t keep track of your cash flow, your business can quickly run out of funds, which can even lead to bankruptcy.
Having said that, calculating your burn rate can also help your business to:
#1. Prevent overspending
More often than not, a high burn rate signifies overspending issues.
If you spot it soon enough, however, a high burn rate can help you to identify unnecessary expenses that you should cut.
For example, if your high rate is coming from renting a luxurious office, you should consider renting a more modest office until your business generates enough revenue to afford an expensive office space.
#2. Identify investing needs
While a low burn rate is generally great for your business, it can also signify that you aren’t reinvesting your money into your business.
If you don’t invest in the future of your business, it’s only a matter of time until you fall behind your competition.
As such, burn rate can help you to effectively manage your money to avoid either overspending or underspending.
#3. Determine financial needs
Calculating your burn rate can help you to identify and plan your revenue needs as well as see how long your business can operate without receiving revenue.
This is especially important for funded startups since their goal is to start generating revenue before the funding money runs out.
As such, by tracking your burn rate, you can find out how quickly your business is losing money, how much money you need to sustain your business, and when to start seeking additional funding.
How to Reduce Burn Rate
Having a high burn rate can be stressful – luckily, there are many ways to reduce your burn rate, especially since it’s closely related to your financial and general business decisions.
Here are some tips to help you reduce your company’s burn rate:
- Cut unnecessary expenses. Cost reduction is key to reducing your burn rate. For this reason, you should analyze which of your expenses don’t directly help you generate revenue and reduce them.
- Focus on churn rate reduction. If your company is losing customers fast, your burn rate will inevitably increase as you receive less revenue. As such, it’s important to focus your efforts on retaining your customers and reducing your churn rate.
- Reconsider your marketing strategy. Most companies spend lots of money on marketing – and while there’s no doubt that marketing is important, you should analyze whether it pays off and, if not, adjust your marketing strategy accordingly.
- Increase product prices. A high burn rate can be reduced by reconsidering your pricing strategy and adjusting your product price. Even if you increase your product prices by just 1-2%, it can positively impact your burn rate in the long run.
- Remove unpopular products. One way to improve your burn rate is by removing products that don’t sell. By discontinuing such products, you can focus your money and efforts on what your company does best and what your customers need.
- Reduce staff or employee compensation. If a large chunk of your expenses comes from salaries, pay cuts or employee layoffs can definitely help you reduce your company’s burn rate.
What’s a Typical Startup Burn Rate?
The best position to be in as a startup is to pre-sell your ideas to customers and get them to pre-pay before you start spending your own money to build your product. This is called customer-financed development.
Many times, though, customers won’t feel comfortable giving you money until they can test the product. In this case, you want to spend as little of your own money as possible and build out an MVP in the shortest amount of time possible. Keep your operating expenses very low until you have your first paying customer. Every small business should start this way.
Orgzit, for instance, spent $100k to build their MVP in 2017 and now they have 21 customers and $60,000/year in revenue.
Wasabi spent $20m to build their MVP in 2017 and now they do almost $18m/year in revenue.
NoteAffect spent $1.6m to build their MVP in 2018 and are still trying to get meaningful revenue (only $30,000 in annual revenues so far).
My Burn Rate is $100k, Is That Good or Bad?
As we’ve discussed, burn rate is relative. If you burned $100k over a month and in that same month you did $75k in revenue, and you still have $100k in the bank, this can be considered a high burn rate. Basically, it means you lose $25k/mo and, looking at your cash flow statement and other financial statements, you only have 4 months of cash runway left.
In such a case, you should consider decreasing costs like office space, or raising additional capital from venture capitalists.
So what are some examples of monthly burn rate from companies today?
MedStack has raised $2.3m, is doing $56,000 per month in revenue and has total expenses of $156k/mo (gross burn rate of $156,000). Net burn rate is $100,000 per month and they have 23 months of cash runway left. This is fine.
DaisyIntelligence has enough cash for 12 months of runway. They’ve raised $15m and do monthly revenues of $575,000. Total monthly expenses are about $1m, meaning net cash burn is -$500,000 per month. These founders will either have to raise more capital in the next 4 months, drive enough new revenue to get profitable in the next 12 months, or they’ll run out of cash.
Churnly.ai is burning $40,000 per month and hasn’t raised any money. The founder has to continue putting in more money each month to cover the losses until the company turns profitable.
AirDNA is making $200,000 per month and hasn’t raised any money. This company is hugely profitable and has a net burn rate of $0, which means they don’t lose money!
Key Takeaways
And that’s all – now you know all there is to know about burn rate, from its formula to burn rate reduction and everything in between.
But, before you go, let’s quickly summarize the key points mentioned in this article:
- Burn rate measures how much money your business spends on all of its expenses in a month (or a different time period).
- Burn rate can help you determine for how long you can sustain your business before it starts generating revenue.
- Gross burn rate refers to your total monthly expenses.
- Net burn rate helps you determine the difference between your cash inflow and outflow.
- Calculating your burn rate can help your company to effectively manage finances.
- There are many ways to reduce your burn rate, including cutting down expenses, increasing product prices, and decreasing your churn rate.