Burn rate is a matter of life and death—startup life and death. It’s the difference between companies that survive for years and those that shutter within months. It’s a critical metric for any investor considering supporting your business. And it’s frequently misunderstood and underestimated by the people who should be paying attention to it most.
Here’s what you need to know about burn rates, including what they are, why they matter, and how to calculate yours—and determine if it’s where it should be.
What Is Burn Rate?
Burn rate is the rate at which a company spends money. It’s almost always calculated as a monthly average. For example, if a company spends an average of $12,000 a month, the company’s burn rate would be 12,000.
Burn rate is a key indicator of a company’s financial health. If you know how much you’re spending each month, as well as how much cash you have on hand, you can a) make better financial decisions and b) communicate more effectively with investors.
Your burn rate can shape strategic considerations such as the following:
- what the size and scope of your budget should be
- whether you’re overspending
- what potential opportunities you have to save money
- how much time a new round of funding will buy your company
- whether you need to prioritize fundraising now or later
Above all, burn rate is essential for finding out your cash runway.
What Is Cash Runway?
Cash runway refers to how much time a company has before it runs out of money. It is a projection based on the organization’s cash stores and average monthly burn rate.
How Do You Calculate Burn Rate?
Determining your company’s burn rate is easy.
To calculate your average monthly burn rate in a year, subtract your current cash from your starting cash, then divide by 12.
For instance, if your company had $500,000 on January 1st and $200,000 on December 31st:
($500,000 – $200,000) ÷ 12 months = a burn rate of 25,000
Note that burn rate can be calculated with or without income factored into the equation. A “with income” calculation can help you understand the long-term viability of your company’s spending habits. “Without income” is a worst-case scenario calculation that indicates how long your company would survive if all your income streams were suddenly cut off.
Calculating Cash Runway
To determine your company’s cash runway, divide your cash on hand by your burn rate. Using our example above, that would mean a company with $200,000 in the bank and a burn rate of 25,000 has a cash runway of 8 months:
$200,000 ÷ 25,000 = 8 months
Note that a cash runway calculation assumes the company won’t raise additional money and won’t experience a drastic change in its financial situation. This is what makes cash runway a fundamental benchmark. It’s the “bare minimum” projection that indicates how long the company could survive without generating any income.
What Is the Right Burn Rate for Your Startup Business?
Regardless of its situation, any company should have a burn rate that ensures at least six months of cash runway. Any less than that and you may not be prepared for unexpected changes in revenue or spending.
In other words, your monthly spending should never dip into the bare minimum of capital you need to keep your business running for the next six months.
Of course, every company is different. A financial strategy that works for one startup may be a major misstep for another. Consider framing your burn rate in terms of growth and deepening your awareness by drilling down into specific metrics such as burn per new hire or burn per department.
If you’ve got the means to embark on a period of growth, then crank up your burn rate for a while and spend some money growing your business. The “means” in this case are tangible resources—for instance:
- lots of cash in the bank
- a strong line of credit
- growing revenue sources
- support from venture capital
If you don’t have those means, it’s a good idea to reconsider your growth plan and maintain a conservative burn rate. That’s regardless of your company’s potential or the level of risk you’re willing to accept.
Intangibles such as the following may be appealing to investors, but think twice before you allow them to influence your burn rate:
- team skill and expertise
- workforce productivity
- growth of the market/industry
- brand awareness/reputation
- third-party valuations
- trade secrets
- client relationships
Always be aware that your company’s survival is closely correlated to your cash runway. When you run a startup, the money you have ultimately matters more than any money you’ll (potentially) make.
Need help determining your company’s burn rate? Want to start spending smarter today? Talk to us.
Quick Note: This article is provided for informational purposes only, and is not legal, financial, accounting, or tax advice. You should consult appropriate professionals for advice on your specific situation. inDinero assumes no liability for actions taken in reliance upon the information contained herein.