Finance guide: Burn rate (calculation, uses, examples)
Learn about the importance of burn rate for your business and how to calculate it
Updated:
April 30, 2024
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Accounting Manager
April 30, 2024
Burn rate is a key metric for startups to monitor. A high burn rate means a startup consumes its available funds quickly, while a low burn rate indicates more efficient cash management.
Startups need to carefully track their burn rate to ensure they have sufficient "runway," meaning the amount of time they can continue operating before running out of money.
Effectively managing burn rate is a delicate balance that founders must master to increase their chances of long-term success.
In this guide, we’ll go over burn rate, why it’s important for entrepreneurs and investors, and how to increase revenue without increasing expenses.
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Burn rate is the pace at which a company spends its cash, and it’s typically measured monthly.
Calculating the burn rate is important because it helps companies and venture capitalist investors understand how long the company's current cash reserves will last before it needs to generate positive cash flow or raise additional funding.
A high burn rate indicates a company is spending cash quickly and may need to cut costs or raise more capital soon.
The burn rate formula is calculated as follows:
(Starting cash balance - Ending cash balance) / Number of months = Monthly burn rate
For example, if a company had $200,000 in cash at the start of a quarter and $90,000 at the end, with the quarter lasting three months, the burn rate would be:
($200,000 - $110,000) / 3 months = $30,000 per month
Gross burn rate is the total amount of cash a company spends each month without considering any revenue or cash inflows.
In contrast, net burn rate is the difference between a company's cash outflows (expenses) and cash inflows (revenue), representing the net amount of cash the company loses each month.
The gross burn rate refers to the total amount of money a company spends during a specific period, not counting any revenue generated during that time.
In other words, it represents the company's total expenses during that time period.
The formula for calculating gross burn rate is simply the sum of all the monthly operating expenses, without considering revenue.
Example:
Gross burn rate = Monthly rent + Monthly salaries + Monthly overhead costs
The net burn rate indicates the difference between a company's total expenses (its gross burn rate or the total amount of money spent during a specific period) and its total revenue, typically measured monthly.
The net burn rate represents the company's monthly cash losses after accounting for revenue.
Investors and companies typically focus more on net burn rate when evaluating financial health and sustainability because it provides a better picture of a company's cash flow and runway.
When calculated monthly, the formula for net burn rate is:
Monthly net burn rate = Monthly gross burn rate - Monthly revenue
For example, if a company has a gross burn of $125,000 per month and $40,000 in monthly revenue, the net burn rate would be $85,000 per month.
Implied cash runway is a time estimate. Given its current burn rate, it refers to the estimated number of months a company can continue operating before depleting its current cash reserves.
The formula for calculating implied cash runway is:
Implied cash runway = Cash on hand / Burn rate (per month)
For example, if a company has $100,000 in cash and a net burn rate of $10,000 per month, the implied cash runway would be:
$100,000 / $10,000 = 10 months
The implied runway is an important metric for startups and early-stage companies, especially those not yet profitable.
It indicates how long the company can continue operating at its current burn rate before raising additional funding or becoming profitable.
Monitoring and managing the implied cash runway is crucial because it helps companies and investors understand their financial health and sustainability.
A longer runway allows the company more time to achieve profitability or secure the next round of funding.
Burn rate is a key metric for startups to monitor because it provides insights into a company's financial runway, spending efficiency, and growth trajectory.
These are crucial pieces of information to secure funding and achieve long-term success.
Burn rate does the following for startups:
Monitoring the burn rate helps startups understand their cash runway, meaning the estimated number of months the company can continue operating with the current rate of expenses before running out of money.
The burn rate measures how quickly a startup is depleting its cash reserves, which helps founders determine how long the company can operate before needing to generate additional revenue or raise funding.
A high burn rate can indicate areas where the company is overspending and needs to address these. These areas include marketing and branding, human resources (HR), and office space costs.
If spending on some of these areas is critical, the burn rate can show how much revenue will be needed to cover these specific costs.
Investors track a startup's burn rate when evaluating investment opportunities.
On the one hand, a high burn rate not accompanied by rapid growth may dissuade investors or prompt them to set strict deadlines for the startup to become profitable.
On the other hand, investors can view a high burn rate (even negative cash flow) positively when the startup is focused on quickly gaining market share, acquiring customers, and generating higher profits.
The run rate estimates the company's forward-looking financial performance based on a previous month or quarter.
This metric estimates a company's potential future annual revenue based on its current financial performance (assuming it will remain consistent throughout the year).
As previously mentioned, the burn rate is a time metric that indicates how long a startup's current cash reserves will last before the company needs to generate positive cash flow or raise additional funding.
It measures the time, typically every month, at which a company will spend the entirety of its cash reserves.
Here are some general principles to help you better understand the concept - including what a good burn rate looks like.
There is no single "great,” “good," or "acceptable" cash burn rate that applies to all startups. The appropriate cash burn rate depends on the startup’s industry, business model, growth stage, funding, runway, sustainability, and investor expectations.
For example, in the early stages, a hardware startup may have a higher burn rate than a SaaS company, a software provider that delivers its applications to customers over the internet through a subscription-based model rather than selling packaged software because of the required expenses to acquire equipment.
As mentioned earlier in this article, early-stage startups that focus on rapid growth and customer acquisition may have higher burn rates.
Startup founders should note that a high burn rate that is not accompanied by rapid growth may cause investors to set deadlines for the startup to become profitable.
More mature startups will likely aim for lower burn rates as they shift towards profitability goals and look to improve their balance sheet's bottom line.
A typical goal is to have 12-18 months of runway so that the startup can operate without running out of cash. Some startups may aim for more than 24 months of runway.
A high burn rate indicates the startup is using its cash reserves quickly. This can lead investors to increase their pressure and startup founders to take drastic cost-cutting measures.
Ultimately, the startup may risk failure if startup founders do not reduce the company’s high burn rate or raise additional funds.
Fixed expenses remain constant in price and frequency, while variable expenses change monthly.
Fixed expenses include rent, internet/cable bills, mortgage payments, loan payments, insurance premiums, subscriptions, and salaries.
Variable expenses change regularly in price and frequency, such as car repairs, travel, freelance and contractor labor, banking fees, advertising and marketing, and taxes. Managing variable expenses is critical for a startup’s long-term success.
Unit economics refers to a particular business's direct revenues and costs, measured per unit. The "unit" can be defined in two ways: either a customer or an item sold.
In SaaS and subscription-based businesses, one unit is typically calculated as the customer's lifetime value (LTV) ratio to the cost to acquire that customer (CAC).
Businesses selling physical products usually calculate one unit as one item sold. The unit economics is calculated as the contribution margin, which is the difference between the selling price per unit and the variable costs per unit.
Unit economics is an analytical framework that allows companies to understand the financial dynamics of their core business model and make data-driven decisions to spark profitability and growth.
Burn rate focuses on the net cash outflow, not just total expenses. It is calculated by subtracting revenue from expenses for the same period. A positive burn rate indicates the company is spending more than it is earning and depleting its cash reserves.
Let’s start with an example of a SaaS startup.
Let's say a SaaS startup has the following financial information for a given month:
To calculate the startup's burn rate for that month, we would use the following formula:
Burn rate = Monthly expenses - Monthly revenue
Burn rate = $120,000 - $100,000 = $20,000
In this example, the startup has a monthly burn rate of $20,000. This means the company is spending $20,000 more per month than it is generating in revenue, depleting its cash reserves at a rate of $20,000 per month.
Let's say a startup has the following monthly expenses:
To calculate the gross burn rate, we simply add up all these monthly operating expenses:
Gross burn rate = $10,000 + $20,000 + $30,000 = $60,000
So, the startup's gross burn rate is $60,000 per month. This represents the total amount of money the company spends each month on operating costs, without taking into account any revenue generated.
In this example, let's say a startup has the following financial information for a given month:
To calculate the startup's net burn rate for that month, we would use the following formula:
Net burn rate = Monthly expenses - Monthly revenue
Net burn rate = $20,000 - $16,000 = $4,000
In this example, the startup has a monthly net burn rate of $4,000. This means the company loses $4,000 each month after accounting for the revenue it generates.
Here is an example of an implied cash runway analysis. Let's set the example of a startup with the following financial information:
We first need to determine the net burn rate to calculate the startup's implied cash runway.
Net burn rate calculation:
Cash runway calculation:
- Cash runway = Total cash balance / Net burn rate
- Cash runway = $60,000 / $75,000 = 0.8 months or approximately 24 days
This analysis shows that with $60,000 in total cash balance and a net burn rate of $75,000 per month, the startup has only about 24 days of cash runway remaining before it runs out of funds.
To improve your startup’s burn rate, there are several critical actions that you can take:
Acquiring customers is costly (whether via marketing or sales methods). When a startup loses customers and constantly has to find new ones, the company loses recurring revenue and the cost of acquiring new ones.
Since customers constantly change, the company loses recurring revenue, which increases the net burn rate. Keeping loyal customers means the company doesn't have to spend as much to maintain a customer base.
One way to reduce customer churn is to deliver more value to existing customers to increase loyalty or enhance the product or product experience.
A company can defer or reduce people-related expenses to help reduce its burn rate in the following ways:
Salaries often account for a significant portion of a startup’s overall burn rate. Laying off employees is one of the most direct ways to cut people-related expenses and lower the burn rate.
Instead of layoffs, a company can reduce the salaries of existing employees to lower people-related expenses. This allows the company to retain talent (even though they will likely not be happy about their salary reductions) while reducing the burn rate in the short term.
Pausing or slowing down new hires can prevent the burn rate from increasing further as the company scales – or if an economic downturn occurs. This allows the company to maintain its current headcount and people-related costs while it grows without adding to the burn rate.
Reducing these costs buys the company more time to increase revenue, improve efficiency, and potentially become profitable before running out of cash.
Key ways a company can increase revenue without increasing expenses include —
NDR measures the year-over-year revenue growth from existing customers, excluding potential new customer revenue. Increasing NDR by upselling, cross-selling, or reducing churn allows a company to grow revenue without acquiring new customers.
Reducing the need to spend more on customer acquisition improves the efficiency of the company's sales and marketing efforts.
CAC is the cost to acquire a new customer, including marketing and sales expenses. Reducing CAC, either by improving marketing efficiency or sales productivity, allows the company to grow revenue without increasing acquisition costs.
This directly improves the company's "magic number," meaning the ratio of new revenue to CAC, which is a key metric for SaaS businesses.
Offering free trials or “freemium” versions of a product or service can increase revenue without increasing expenses. A freemium version of a product or service offers a basic version for free while also offering a premium or paid version with additional features and functionality.
This allows the company to grow its customer base and upsell to paid plans without proportional increases in expenses.
Developing new products, services, or business lines can diversify the company's revenue sources. This allows the company to grow top-line revenue without relying solely on its core offering, which may have higher associated costs.
Optimizing pricing, bundling, and packaging can increase the average revenue per user (ARPU) without adding new customers. This can boost revenue without increasing the company's overall cost structure.
Evaluate the startup's product or service portfolio and eliminate low-performing offerings to reduce expenses and improve the overall burn rate, a critical metric for the business's long-term sustainability.
To do this, identify and eliminate unprofitable products or services, focus on core competencies, improve profitability and cash flow, and increase operational efficiency.
Refinancing high-interest debt is an effective strategy to reduce the burn rate and extend the financial runway. When refinancing, negotiate more favorable terms such as lower interest rates, longer repayment periods, or reduced fees.
Cash management systems can automatically pull data from bank accounts, accounts receivable, accounts payable, and other sources. This allows the startup to get a real-time, comprehensive view of the cash inflows and outflows to create accurate cash flow forecasts.
By analyzing the cash flow data, startup founders can address cash flow gaps, such as securing additional financing or delaying/removing non-essential expenses.
Cash management systems can help the startup better manage its accounts receivable, accounts payable, and inventory to free up cash. This improves the company's overall cash conversion cycle and reduces the amount of cash tied up in operations.
A cash management system will help to proactively plan, monitor, and optimize the startup’s cash flow, which is key for reducing the burn rate and extending its financial runway.
When startups raise money, investors examine their burn rate closely. The burn rate provides critical insights into the startup’s financial health, capital efficiency, growth potential, cost control, and future funding requirements.
The key is finding the right spending balance, enough to fuel growth but not so much that the business becomes unsustainable.
Even though startup founders should be strategic about how to spend, it is not advised to stop spending drastically. A falling burn rate can indicate that business is going so poorly you have to pull back operations. This is an easy way to lose trust in investors.
Many startup founders are tempted to increase their spending (burn rate) as their sales grow, especially if the company meets its financial goals.
If each dollar invested generates $5 in profits, spending more aggressively will help capture more market share, even if it delays profitability. This high-burn strategy can pay off if the company grows very quickly, leading to a stronger market position and higher long-term profits.
Investors usually prefer to see startups spend heavily to fuel growth rather than cutting costs to lower the burn rate.
However, if a startup's finances start deteriorating and it has less than a year's worth of runway left, it may have no choice but to reduce its burn rate quickly to avoid going out of business.
Reducing the burn rate is often seen as a last resort, as it can be difficult for startups to recover from major spending cuts, especially layoffs.
Always keep an eye on your runway and consider the timing of your next fundraise based on how your business is performing and whether you believe you’ll receive the right terms.
In general, plan accordingly to avoid raising money out of desperation.
The best rounds happen fast when you don't need the money. If your burn is too high, and you need the money, potential investors will know and view it as a negative signal.
Burn multiple is a valuable metric that provides insights into how effectively a company converts its cash into revenue growth, which is crucial for startups and investors. It measures a company's burn rate ratio to its net new revenue.
The burn multiple is a metric that will be impacted by any serious business problems, such as gross margin issues, sales efficiency problems, customer churn, or growth challenges.
The burn multiple is calculated by dividing the company's net cash burned (cash spent minus financing/investment received) by its net new Annual Recurring Revenue (ARR).
Burn multiple formula:
Burn multiple = Net cash burned [Cash spent - Financing/investment received] / Net new Annual Recurring Revenue (ARR)
For example, if a company spent $100,000 in net cash and generated $40,000 in net new ARR, the burn multiple would be 2.5 ($100,000 / $40,000).
The burn multiple is interpreted as a measure of how efficiently a company is using its capital to generate new revenue growth.
As a startup matures, the burn multiple should decrease. A lower burn multiple (e.g., under 2x) is generally seen as more favorable, indicating the company is generating more revenue with less capital. If the burn multiple increases over time, that indicates something is wrong, even if headline growth is still increasing.
Burn multiples above 3x may indicate issues with cost control, gross margins, sales efficiency, or customer churn. Founders can improve the burn multiple by cutting costs, as it instantly adjusts to the most recent period.
Analyzing a company's historical burn multiple can provide valuable insights into product-market fit (PMF) because it shows how efficiently the company converts its capital into revenue growth. The PMF is the sweet spot where a company's product effectively meets the needs of its target market, resulting in strong customer adoption, satisfaction, and growth potential.
So, a decreasing burn multiple over time signals an improved position regarding product-market fit, as the company is generating more revenue with less capital. Conversely, a persistently high or increasing burn multiple can indicate issues with PMF, such as gross margin problems, sales efficiency, or customer churn.
Burn rate measures how quickly a company spends its cash, while burn multiple examines how efficiently that cash is being used to drive new revenue growth. Both metrics are important for companies to monitor and manage.
A high burn rate means the company is spending its cash reserves very quickly, while a low burn rate means spending more slowly.
A lower burn multiple (e.g., under 2x) is generally seen as better because the company generates more revenue with less cash spent. If we go back to our example about spending on sales and marketing, if a startup spends the same amount month after month on sales and marketing and yet drastically increases sales, that’s a good indicator that the company is generating more revenue with less cash spent.
No. While these two terms are related, they are not the same thing. Burn rate is when a company spends its available cash, typically measured every month.
Expenses refer to the total expenditures and costs incurred by a company, including fixed and variable costs, regardless of whether they are paid for with cash reserves or revenue.
A startup's burn rate is a key metric that directly impacts its runway, meaning the time it can continue operating before running out of cash. Managing the burn rate is essential for a company's long-term sustainability, as it determines how quickly the business will deplete its resources if it cannot become self-sustaining.
Gross burn rate is a metric that shows total spending, while net burn rate provides a better picture of a company's cash flow and runway.
Gross burn rate is the total amount of money a company spends in a specific period, excluding any revenue generated. It represents the company's total monthly expenses.
Net burn rate is the difference between a company's total expenses (gross burn) and total revenue, typically measured monthly. It represents the company's monthly cash losses after accounting for revenue.
Investors and companies typically focus more on net burn rate when evaluating financial health and sustainability.
Businesses can employ the following key strategies to manage their burn rate effectively:
The key is to take a proactive, data-driven approach to managing cash burn while exploring creative ways to increase revenue and extend the company's financial runway.
Venture capital investors closely monitor burn rate, which provides insights into a company's financial stability, spending efficiency, growth potential, capital requirements, and overall market reputation.
A startup’s burn rate indicates how long the company's current cash reserves will last before it needs to generate positive cash flow or raise additional funding. For example, a high burn rate may indicate the startup is not effectively utilizing its resources or is spending excessively on non-essential areas, which can decrease investor confidence.
If a startup’s high burn rate is not accompanied by substantial revenue growth or market penetration, investors may question the company's ability to scale efficiently and generate sustainable revenue.
A high burn rate also suggests the startup will require additional funding sooner rather than later, potentially diluting the ownership stake of existing investors.
This can create uncertainties about future fundraising efforts and the dilution of their investment, affecting investor confidence.
Suppose a startup has a high burn rate without significant revenue growth or a clear path to profitability. In that case, it can create a negative perception in the market not only with investors but also with potential customers, partners, and even potential employees.
Startups can take a proactive, data-driven approach to managing cash burn while exploring creative ways to increase revenue and extend the company's financial runway. This is where business meets creativity.
To reduce burn rate and conserve cash, companies can reduce expenses, increase revenue, improve cash flow management, such as exploring accounts receivable financing to get cash faster from outstanding invoices or identifying and eliminating unprofitable business lines or product offerings, secure additional funding, and improve financial planning and visibility.
The key is a proactive, data-driven approach to managing cash burn.
The good news about burn rate and runway is that you can take action to help give your startup the room it needs to grow into the goals you (and your investors) are eying.
A few examples include improving your sales and cutting non-essential expenses. Another option: Managing your cash with a solution like Rho.
With Rho, you can manage your operating cash in a Business Checking account - free from ACH or platform fees - plus earn yield using Rho Treasury, which invests your cash in T-Bills held directly in your company’s name.
Learn more about how Rho Treasury can help put your company’s cash to work and extend your runway today.
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