What is burn rate?
A company’s burn rate is the pace with which it goes through its cash reserves. The term is almost always used for startups and scaleups, which often have a set amount of venture capital invested in them. How quickly they spend this cash reserve is the key question.
This is a measure of negative cash flow - how much money leaves the business. And we usually talk about a company’s monthly burn rate. If a company has a burn rate of $500,000, it’s spending $500,000 per month - regardless of how much money comes in through sales or other revenue.
Types of burn rate
There are two key types of burn rate: gross and net.
Gross burn rate: The total amount your company spends each month, including all fixed and variable costs.
Net burn rate: The amount your company loses each month, accounting for revenue. Any net burn rate suggests that the business is not profitable.
Since this measure most often applies to cash inefficient startups and scaleups, we most often think of gross burn rate. These businesses are usually not expected to be profitable for some time.
Both of these can also be expressed as a pure number or a percentage. You may simply want to track the total amount spent per month. But you may also want to track either gross or net burn rate as a percentage of your cash reserve.
Burn rate calculation
Calculating burn rate is relatively simple, in theory. But since there are several types of burn rate you may need to consider, here are the different formulae to use:
Gross burn rate (number) = Monthly expenses (rent + payroll + travel + utilities, etc)
Gross burn rate (percentage) = (Monthly expenses / Starting capital) x 100
Net burn rate (number) = Income - Monthly expenses
Net burn rate (percentage) = ((Income - Monthly expenses) / Starting capital) x 100
Why does your burn rate matter?
In very simple terms, if your operating expenses are higher than your income, you’re not profitable. Profitability will usually be the ultimate goal for most businesses, even those that are expected to take years to achieve it.
For example, startups backed by venture capitalists often choose to spend quickly in the early stages. Marketing and sales can be very high while customers are hard to find. And you also need to invest heavily in R&D and create competitive products.
These companies have a very high burn rate, “overspending” in relation to revenue. While that’s part of the plan, you still need to track your total cash balance closely. That $30m series B funding may dry up quickly, and the next round of investors will want to know exactly where it’s gone.
And particularly in an economic downturn, investors and markets prefer companies with a better chance of sustainability.
In short, you must at least be able to measure burn rate accurately and understand your operating costs. This way, when the time comes to slow the rate and aim for profitability, you have a clear roadmap.
How to manage your cash burn rate
The obvious benefit of understanding and tracking your startup burn rate is to be able to slow it if necessary. This increases your cash runway, and keeps you in a stronger cash position for longer. Here are a few simple strategies.
Set clear expectations
For any new company, seeing a significant amount of cash leave the bank account each month can be frightening. But if you’re running a growing startup, this should be part of the plan.
Most startups aim for 12-18 months of runway. This means that if they spend at an acceptable speed, they will need additional funding in 12-18 months. If they have a higher burn rate than expected, they’ll either need fundraising sooner (often at a lower valuation), or slow their spending.
Some may choose to spend faster and raise funds more regularly as part of their business plan. Whichever you choose, make sure that your investors and senior leadership are aligned. You don’t want to panic after six months.
Track costs centrally
Most companies struggle to manage cash effectively because they have a wide, disjointed array of costs. When you have rent payments coming from the bank account, invoice payments going out to suppliers, credit card payments for utilities and travel, and expense claims for all the rest, keeping track of these is a huge challenge.
You don’t want to spend weeks updating your cash flow statement each month. Tracking current cash and expenditures is far simpler once you consolidate payment methods.
For example, a spend management solution manages your invoices, card payments, and expense claims in one place. When you need to see what’s spent each month, there’s no data entry or detective work to do.
Interrogate your expenditures
If the goal is to bring your monthly burn rate down, you need to cut costs in some way. First, look at your fixed and variable expenses. Fixed expenses are more likely to be locked in for a longer period - things like office space, salaries, utilities, and long-term SaaS subscriptions. These are often harder to cut quickly, but you may still have room to negotiate.
Variable costs are the monthly expenses which aren’t fixed and can easily be decreased. These might be advertising (including social media), travel, catering, gifts, consultants and freelancers.
Dive into expenditures on both a macro and micro level. What are the big picture costs eating into your cash runway? Is marketing efficient for you so far, or are the costs to produce your goods and services higher than you’d like?
Cut costs strategically
The key to effective cost cutting is to understand the impact of each expense, and simply reduce spend in low-performing areas. For example, you may spend a huge amount on social advertising, but still generate more than you spend. You certainly shouldn’t cut this, then. But you may find individual campaigns within that advertising which don’t perform and cut these.
The goal should never be to cut 15% across the board. Rather, cut close to 100% of the things that don’t work. Keep investing in the ones that do, and try to save some cash for new initiatives.
Take full control of company cash
As mentioned above, the first true step to controlling company spend is to track payments effectively. The easier it is to see who pays for what, why, and when, the easier it becomes to keep costs in line.
A good spend management solution is your best friend. It shows you every payment as it happens, with a clear approval trail. It also prevents unapproved spending and helps you track budgets live.
Keep your financial statements up to date in real time, and focus on the harder questions: how to build your customer base and increase revenue.