If you’re out of cash, you can’t exist as a company. Every founder knows this. There are many ways to get cash into your company ranging from selling more to customers, raising capital, letting customers pre-pay, or even selling a minority stake in the business.
So how much money should you spend to try and grow your business? This is called your burn rate.
What is Burn Rate?
Burn rate measures how much money leaves your company bank account each month. You can calculate it by taking total revenue and subtracting what you spend to get that revenue.
$1m in revenue – $600k in total expenses = $400,000 in cash flow and a net burn rate of $0. This company is profitable and cash flow positive!
$1m in revenue – $1.5m in total expenses = -$500,000 in cash flow which is the same as a burn rate of -$500,000 or -50% calculated by taking: -500k in cash flow/$1m revenues)*100.
Sometimes founders call this an EBITDA (earnings before interest, taxes, depreciation and amortization) margin of -50%.
A good burn rate is one where you can afford to keep going for at least 12 months at that same rate. This means 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.
What is Gross Burn Rate?
Gross burn rate measures how much total money you spent in a month before adding back revenue you made in that same month. In our example above, gross burn is $1.5m to get $1m in revenues, and net burn is -$500,000.
Gross burn rate is an important thing to measure so you can quickly answer the question: If we lost all of our revenue tomorrow, how many months could we stay in business?
If your gross burn is $1.5m, and you have $3m in the bank today, you could stay in business for 2 months without any revenue. You have 2 months of cash left in the bank. Always watch your balance sheet so you know how much cash you have left relative to your total amount of expenses.
It would take a massive disaster, or catastrophic event for you to lose all your revenue so a more valuable metric to pay attention to is Net Burn Rate.
What is Net Burn Rate?
Net burn rate measures how much money you lost in a month (or any time period) after adding back revenues. If you spend $3m in a month, you might think “wow, thats a lot!”. But if you spend $3m to get $6m in revenue, that looks pretty good!
Net burn rate puts your expenses into perspective. It helps answer the question: “Are you profitably spending money?”
If you raise venture capital, you’ll have many months where your net burn rate increases as you invest the venture capital money. The idea is you invest this amount of cash and increase the company’s burn rate to drive additional future revenue growth. In these situations, negative cash flow is fine as long as you know the number of months it’ll take you to get back to positive cash flow.
This is very common in early-stage companies as they invest their cash reserves to build an MVP of their product.
How do Gross Burn Rate and Net Burn Rate work together?
Lets look at very simple version of a profit and loss statement to look at the burn rate calculation.
-(Cost of goods sold, COGS)
=Gross Profit (profit margin calculated here)
=Profit/Income/Cash Flow or Cash Burn
Gross burn rate equals Cost of goods sold + All expenses.
Net burn rate equals Total Revenue – Cost of Goods Sold – All Expenses.
You can have a “very high” gross burn rate but still be cash flow positive each month (a very low net burn rate) as long as revenues are higher than expenses. For the CFO’s reading, we’re assuming in this article that revenue and expenses accurately capture cash in and cash out of a business in any given month.
What is 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, customers won’t feel comfortable giving you money until they can test the product. In this case, you want to spend as little as 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 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 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 Monthly Burn Rate is $100k, Is that Good or Bad?
As we’ve discussed, burn rate is relative. If you burn $100k over a month’s period of time, and in that same month you did $75k in revenue, and you still have $100k in the bank, this would be a high burn rate. You lose $25k/mo and looking at your cash flow statement and other financial statements you only have 4 months of cash runway left.
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 to profitability 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, they don’t lose money!
Burn rate allows you to figure out how much time you have to drive growth before you run out of money. Track your expenses by each line item and make sure they are investments that’ll help you work towards cash flow positive in a short amount of time.
For some startup companies, this may take 12-18 months but you should always have a plan for how much you intend to spend building your MVP. Force yourself to sell a customer at some point otherwise you end up spending way too much money building something that no one wants.