2 min read
Money is key to the success of any business. Understanding how quickly cash is going out of your business is just as important as tracking incoming cash flows. That’s why knowing your burn rate is critical. Learn more about burn rate and how to calculate cash burn rate with our definitive guide.
What is burn rate?
Burn rate is the term used to describe how fast a company is spending money. Often, burn rate is calculated per month, but it can be adjusted for any period. Burn rate is essential for all businesses, but it is especially crucial for start-ups who rely on burn rate to predict when they need to become profitable.
Who uses cash burn rates?
Burn rate is used most frequently by start-ups. The burn rate shows how much money a company uses before it starts generating income. Start-ups often spend more money than they make while still growing a customer base. The burn rate can also show how much longer a company has before it runs out of money. This is known as “runway.”
Types of burn rate
There are two types of burn rate:
Gross burn rate: Gross burn rate is the total amount of cash spent each month, including operating expenses such as rent and employee salaries.
Net burn rate: Net burn rate refers to the rate that a company is losing money.
How to calculate cash burn rate
There is a different cash burn formula for each type, with one accounting for expenses and the other accounting for overall losses. Here’s a burn rate calculation example for gross burn rate:
And here’s the formula for net burn rate:
Burn rate example
A fintech start-up has monthly costs of $24,000, consisting of $4,000 on office rent, $10,000 on servers, and $10,000 on salaries. This would make the burn rate $24,000. However, if the company is earning revenue, this changes the burn rate.
For example, if the business is earning $10,000 per month, even if it’s burning $24,000, that gives it a net burn rate of $14,000, a loss that is less than its $24,000 outgoings might imply. While this difference may seem small, it can significantly impact the business’s overall prospects. For example, if the company has $100,000 in the bank, with £14,000 losses a month, they have a runway of around seven months, not four months (as would be the case with a $24,000 loss).
An investor will continue to look at the burn rate even after investing. If the burn rate continues to worsen, it’s a vital clue that the business is not being run effectively. A company can be salvaged from a worrying burn rate, though not without sacrifice. High burn rates will have to be remedied by targeting cost drivers like staff and premises. This can mean downsizing offices and letting go of staff.
How accurate is burn rate?
The cash burn formula is a simple way to understand how a business uses its funds, but it has limitations. The burn rate itself only shows how much money is being spent, not why it’s been spent. Even when faced with an alarmingly high cash burn, the burn rate calculation alone will not provide any solutions. Further investigation will be needed before a solution can be found.
How can I reduce burn rate?
As mentioned above, the burn rate alone will not necessarily identify your trouble areas. If there is no apparent cause, then consider one of the following:
Pay cuts either for key staff or staff as a whole
Layoffs, if necessary
Reducing hiring (start-ups are often at risk of hiring too soon)
Make sure you’re chasing any payments that you’re due
Avoid making any large purchases unless it’s an investment that will immediately increase revenue, i.e., a card reader for a previously cash-only business
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.