Burn Rate

What is the Burn Rate?

The burn rate is the percentage rate at which a company is spending its cash reserves (normally in excess of revenue). It’s a particularly crucial metric for early-stage startups, which generally rely heavily on investor funding to sustain operations until they can generate sufficient revenue to turn a profit.

Burning cash isn’t always bad. In fact, there are plenty of instances where it’s required:

• Research and development. Building a software, biotech, or pharma product? You’ll need to spend months developing it before you can bring it to market.
• Scaling operations. Investing in infrastructure, technology, and other operational capabilities to scale up business operations can lead to significant expenses before generating proportional increases in revenue.
• Staffing up. 1 or 2 employees is relatively easy to account for. But hiring 10 at once and getting a new office space will require a huge upfront investment.
• Sales, marketing, and advertising. Entering new markets or expanding your customer base results in high marketing, sales, and distribution costs.
• Early-stage expenses. Regulatory compliance, debt servicing, and everyday operating expenses cause cash burn if the company isn’t mature enough to have a steady revenue stream.

A high burn rate (compared to the amount of cash the company has) signals a higher likelihood the company will enter a period of financial distress. Businesses should shoot for a monthly burn rate of 1/12 their available cash. This ensures they have at least a year before running out of cash, (and that’s being conservative).

Synonyms

• Cash burn rate
• Startup burn rate
• Negative cash flow

Understanding Burn Rate

When you calculate your company’s burn rate, you’re answering the question, “How long can we continue to operate before we needs to secure additional funding or reach profitability?”

Venture capitalists and angel investors care about their investment prospects’ burn rates for a similar reason: They want to understand how long their funding will last, how responsible the company is with its finances, and whether they’ll need more financing. Ultimately, they also want to know if/when they can expect to see a return.

There are two metrics businesses and investors use to arrive at these conclusions: gross and net burn.

Gross Burn Rate

Gross burn reflects the total amount your company spends per month. It includes all your operating expenses — payroll, rent, utilities, you name it. It’s a straightforward measure of your company’s cash outflows without considering any incoming revenue.

You use gross burn to evaluate the company’s operational expenditure in isolation, which helps identify areas where you can trim costs. It’s particularly useful when you want a clear picture of your company’s cash consumption rate irrespective of its revenue-generating activities.

Gross burn is also crucial during financial planning and budgeting. It provides a baseline understanding of how long the company can sustain operations with its existing cash reserves, assuming no additional income.

Net Burn Rate

Net burn takes into account your company’s revenue. It provides a net figure of cash loss or gain each month. When you subtract your operating costs from the revenue, you’re left with how quickly you are consuming your capital after accounting for your income.

Use net burn for more nuanced financial analysis, especially if you’re evaluating the company’s overall financial health and sustainability. It gives a better sense of how long the company can continue to operate at its current spending and revenue generation rates.

Your net burn helps you assess operational efficiency. It’s also useful in strategic decision-making, particularly in scenarios where the goal is to demonstrate a pathway to profitability or explain funding requirements to keep the lights on.

Cash Runway

A company’s burn rate affects their “runway,” which represents the amount of time they have before their cash reserves run out. If a company has $500,000 in the bank and an average monthly burn rate of $50,000, that company’s cash runway is 10 months.

Low burn rates equal longer cash runways (which are good for business). If you can last a full year without needing more funding, you’re in a solid place.

Measuring a Company’s Sustainability

A low burn rate by itself isn’t enough to guarantee a successful business. Ultimately, it comes down to whether the company’s product is a good fit for their target market and if they can successfully scale it. At the growth stage, there are tons of variables to consider.

That said, it’s still one of the most valuable metrics in venture capital investment and business decision-making.

Importance for Startups

Understanding your burn rate helps you prioritize and allocate their resources efficiently, ensuring that spending aligns with strategic goals and growth plans. It also gives insights into the financial risks your company faces, enabling it to make informed decisions to mitigate these risks.

But high burn rates might be justified in cases where the company is investing heavily in growth or expansion, which could be sustainable if such investments yield returns in the future. Plus, it doesn’t account for non-financial elements like market conditions, competition, product viability, and team performance, which can all impact a company’s sustainability.

To get the full picture, you have to understand market demand, competition, and overall economic conditions. Founders must also consider their plans for future capital raises, as a high burn rate might necessitate raising capital sooner, which could dilute ownership if they don’t plan it properly.

Importance for Investors

For some companies, generating revenue right away is impossible. SaaS products, biotech R&D, and not-yet-launched services all require huge upfront investments before they’re fully functional, which can take years. Even after GTM launch, many companies need to iterate on sales and marketing strategies before generating enough revenue to cover their expenses.

That’s why you can’t evaluate a company solely on its cash position. You also have to consider factors like revenue growth or customer acquisition cost. That’s why high-growth software investors use the Rule Of 40: If a SaaS company has more than 40% growth + profit, it’s on the right track to sustainable success.

How to Calculate Burn Rate

We calculate burn rate in monthly terms — e.g., “Company X’s burn rate is $50,000 per month.” In that sense, ‘burn’ and ‘negative cash flow’ are synonymous. Company X is spending $50,000 per month in excess of revenue.

However, a more complete definition includes a specific time period: “Company X’s burn rate is $50,000 per month over the last six months.”

In this example, we’re saying that Company X’s cash balance has decreased by an average of $50,000 per month for the last six months.

Burn Rate Formula

To calculate the burn rate, you need to know two key numbers: your monthly expenses and your current cash balance.

The gross burn rate formula is as follows:

Gross Burn = Monthly Operating Expenses / # Months

The net burn rate formula is:

Net Burn = Gross Burn – Monthly Revenue

Burn Rate Calculation Example

Let’s say a startup incurs the following monthly operating expenses:

• Salaries: $50,000
• Rent: $10,000
• Utilities: $2,000
• Marketing: $8,000
• Miscellaneous: $5,000

To calculate the gross burn rate, you would sum all these expenses:

• Gross Burn Rate = Salaries + Rent + Utilities + Marketing + Miscellaneous
• Gross Burn Rate = $50,000 + $10,000 + $2,000 + $8,000 + $5,000
• Gross Burn Rate = $75,000

Now, let’s say the startup generates some revenue from product sales and service contracts:

• Product sales: $40,000
• Service contracts: $15,000

We calculate the net burn rate by subtracting the total revenue from the gross burn:

• Net Burn Rate = Gross Burn Rate – Total Revenue
• Net Burn Rate = $75,000 – $55,000
• Net Burn Rate = $20,000

Let’s say the company has $500,000 in cash reserves. When you look at the gross burn rate, it may seem like the company is in trouble. But when you consider their revenue, you see that they’re still generating income and can continue to operate for quite some time before needing additional funding.

Ways to Improve Your Burn Rate

There are plenty of common cost-cutting measures — reducing staff, minimizing office space, and eliminating non-essential expenses (like travel and entertainment). But the most significant changes come from from innovative strategies that extend beyond the basics.

Here are some of the best ways for businesses to effectively lower their burn rate:

Implement a dynamic staffing model.

Rather than having a fixed number of employees, you might want to consider scaling up or down based on current project demands. Hire a smaller number of core full-time employees and supplement them with freelancers or contract workers whom you can engage when you need to.

This will reduce your fixed salary costs and adapt to workload fluctuations. Plus, it’ll save you from having to go through a round of short-notice layoffs or scrambling to hire a bunch of new employees if you need to ramp up unexpectedly.

Leverage technology for automation.

Identify repetitive, manual processes across the company that can be automated using technology. Automation can significantly reduce the time and human resource expenses associated with these tasks, thereby lowering operational costs. For example, using chatbots for basic customer service inquiries lessens the need for a larger customer service team.

Take (or keep) your company fully remote.

Companies shifting to remote work save an average of $10,600 per employee per year. Plus, it’ll broaden your talent pool and reduce hiring costs. If you have to bring your core staff members in-house for something hands-on (like developing and executing a GTM strategy), at least don’t tie yourself to a long-term lease or make in-office or hybrid work a long-term policy.

Outsource non-core activities and functions.

Admin tasks, HR functions, and specific types of marketing services (e.g., SEO, web design) are easy to outsource to third-party providers. This way, you don’t have to hire specialized staff for these duties (and deal with the costs associated with onboarding, salaries, benefits, etc.).

Optimize product development cycles.

Streamlining product development processes to reduce time-to-market can significantly cut costs associated with prolonged development phases. Using agile methods and lean principles focuses resources on high-value features, which cuts waste in development.

Pursue partnerships with other companies.

Depending on the nature of your business, this could be:

• Revenue sharing
• Joint marketing efforts
• System integration partnerships
• Reseller agreements
• An affiliate program

This allows you to leverage other companies’ resources, expand your reach, and acquire new customers without having to scale up your in-house team or invest in additional marketing collateral.

Monetize excess capacity.

Identify underutilized assets or resources within the company and find ways to monetize them. For example, if a company has unused office space, it could be rented out. Similarly, excess computing power could be leased to other entities.

Conduct regular financial health checkups.

Regularly review and analyze the company’s financial statements and performance metrics to identify areas where costs can be optimized. Taking a proactive approach ensures the company remains agile and can adapt quickly to reduce its burn rate when necessary.

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