Accurate small business accounting is the difference between (startup) life and death, and ignorance of an out-of-control burn rate is one of the top symptoms of a company in trouble. Paul Graham, the founder of Y-Combinator, once said that “When startups die, the official cause of death is always either running out of money or a critical founder bailing,” and although we can’t help with your founder relationships (though we do know a good couples counselor who might help), we can definitely offer guidance for preventing the former by helping you manage your startup spending. Here’s how.
Why Burn Rates Matter (Especially for Small Businesses)
Burn rate refers to the change in the amount of cash a company has over a specific period of time (typically a month). For example, if a company spends $10,000 a month, their “burn rate” would be 10,000. The reason startups pay attention to their burn rate is simple: it helps businesses calculate how long they’ll be able to survive off of their current cash. When you know your burn rate as well as your total amount of cash, you’ll be able to calculate your cash runway, which is the amount of time your company can survive off of its current cash stores at its current average monthly burn rate.
Read more about both of these terms in our glossary of 108 accounting terms for business owners and CEOs:
It goes beyond monitoring your monthly spending habits:
Many times, people have a hard time seeing hidden cash ramifications to growth. Take payroll, for instance, aside from the employee wage and their taxes and benefits, their capital expense purchases and subscriptions such as software seats are also accounted for in the burn rate.
This becomes very important when seeking funding:
Knowing your burn rate will help an entrepreneur understand how much “time” a new round of funding will buy them (and whether or not they need to curb their spending).
Burn rate can be calculated with or without income factored into the equation. “With income” helps business owners understand the long-term viability of their spending habits, and “without income” is sort of a worst-case scenario calculation that will tell a business owner how long they can survive if all of their income streams were suddenly cut off.
In Search of the “Perfect” Burn Rate
Every company is different, so what works for one company isn’t going to work for everyone. Consider thinking about your burn rate in terms of “burn per new hire” or “burn per department” to help you keep your growth in line with your cash stores and burn rate. According to Mark Andreessen, the estimated average fully burdened cost per employee at Series A startups over time is $200,000 per year. So if you’re in the middle of a big growth period or planning for one, take note: overscaling is a big reason why companies run out of money.
If you’ve got the means to embark on a period of growth, by all means crank up the burn rate for a while and spend some money growing your business. The “means” in this case are resources like:
- Lots of cash in the bank
- A strong line of credit
- Growing revenue sources
- Support from venture capital
If you don’t have all those things going for you, it’s a good idea to rethink your growth plan and keep a conservative burn rate. However, no matter what, it’s important to pay close attention to your cash runway. Six months is the absolute least amount of runway you should ever have. Any less than that, and you may not be prepared for unexpected changes in revenue or spending.