Burn Rate Meaning
The burn rate is the rate at which a business is spending money each month to cover its expenses.
There are two types of burn rate: the gross burn rate and net burn rate. The gross burn rate is the cash a business spends every month while the net burn rate is a difference between cash out and cash in. A profit-making enterprise will have a negative net burn rate since it is bringing in more money than is going out.
The net burn rate is equal to the net income on the profit and loss statement. To calculate the monthly net burn rate, subtract the total monthly income by the total monthly expenditure. For example, if the expenses for the month totals $200,000 and the income is $150,000, the net burn rate is $50,000. The gross burn rate is the total expenditure in the month.
By tracking the burn rate, a business can forecast when it could run out of money. The business can determine its cash runway which is the number of months it will take for it to get to the ‘doomsday’ scenario of zero cash. Calculating the cash runway entails dividing the money in the bank by the monthly net burn rate.
On the other hand, a negative burn rate can show when the business will have accumulated enough cash to finance expansion.
Due to varied factors such as sales seasonality, the net burn rate can fluctuate month on month. So on good months that effectively increase the cash runway, the business could increase spending on growth and expansion.
Likewise, if some bad months considerably shrink the cash runway, cutting down non-essential expenses may be the way to go. A startup should look to have at least 12 months of cash runway. Anything below 6 months should trigger radical cost cutting or a plan to raise funding quickly.