How to calculate burn rate & cash runway for your startup?

Author: Partha Chakraborty Published on: June 28, 2022 Published in: Uncategorized

Burn rate & cash runway are two essential terms a startup founder or entrepreneur should know and always keep track of.

Keeping track of the monthly cash burn rate and cash runway in a startup or small business is essential to help know how long the business has before running out of cash.

Contents hide

1 What is burn rate?

2 What is cash runway?

3 How to calculate burn rate?

4 Gross Burn

5 Net Burn

6 How to use burn rate to determine cash runway?

7 How to use burn rate to determine cash runway?

7.1 What is a good burn rate?

8 Why Does Burn Rate Matter?

9 Why do VCs keep putting in more money on loss-making startups?

10 Improving Burn Rate Metrics

What is burn rate?

Burn rate, also known as Cash Burn or Cash Burn rate is the total amount of money that a company spends every month, covering all its costs:

salaries
office rent
marketing
overheads and incidentals

The burn rate is usually quoted as how much cash a company spends each month. For example, if a company is spending $1 million every month, it would mean that the company has a monthly burn rate of $1 million.

Burn rate is an important measurement for both startups and startup investors. Startups focus on using the money from investors well. Both need to understand how much time the startup has before it needs to raise money or die.

What is cash runway?

The cash runway, also known as the Cash-out date, is the amount of cash left in the business to run operations. It is usually measured in “months”. So if a company has $ 1 million in cash and burns $100,000 every month, the company has 10 months of runway to make the startup successful either by making profits or raising more venture capital money, before it runs out of cash.

Entrepreneurs keep track of three things:

how much cash they have,
how much money they are spending each month.
what is their runway?

These three things are interlinked.

How to calculate burn rate?

Burn rate is how quickly a business is losing money. This is important for startups and businesses that get money from investors. They might lose money on purpose to invest more in the business.

This calculation helps business owners understand how long they can continue to operate at their current rate before running out of money. This is called the “cash runway.”

To calculate your own burn rate, you’ll need to look at your cash balances over a period of time. If you want to see your burn rate based on last quarter’s spending, for example, input the cash balance you had at the beginning of the quarter, the balance at the end of the quarter, and the number of months (3 months in this case)

The calculation for burn rate is easy to do, especially if you have a cash flow statement. The formula is simple:

Burn Rate = (Starting Balance – Ending Balance) / Number of Months

Let’s say that your startup had $100,000 when you started. And then you immediately raised $1 million in funding from investors. This brings your starting cash balance to $1.1 million.

Now that you have the money, you can invest in your business. This might mean hiring more people, spending money on marketing & advertising, renting a spacious office, etc.

As you spend your money, you will see your cash balances decrease.

After three months, you check back in and see that your cash balance has dropped to $800,000. This means that your business is losing $100,000 per month.

($1,100,000 – $800,000) / 3 months = $100,000/month

To calculate burn rate, you need to choose a period of time that is long enough to give you an accurate average.

If you calculate burn rate using data from only one or two months, any fluctuations in spending may give you an inaccurate read on how quickly your business is, in fact, spending money.

If your business spends $50,000 in the first month and then $125,000 in each of the following two months, it would give you an unrealistic view of how long your cash will last, if you only looked at the first month.

For that reason, it’s important to use a long enough time period for better accuracy.

You need to be careful about how much money you spend and when you might need to get more money from other people.

Gross Burn

Gross burn is the amount of money your business spends on everyday expenses like payroll, rent, and taxes.

This metric measures how much your business is spending each month. This includes the salaries, rent, and utilities of your business. If your business is spending $50,000 each month, then the gross burn rate would be $50,000 per month.

Net Burn

Net burn rate is a way of measuring how much money you lose in a month, but also takes into account revenues. You subtract all your spending and expenses from revenues, to find out how much money was lost that month.

How to use burn rate to determine cash runway?

Burn rate is a key factor in finding out cash runway, or how long your business can survive before the business runs out of money.

The formula for cash runway is:

Cash Runway = Current Cash Balance / Burn Rate

Looking back at our previous example, if our startup has $800,000 in cash remaining and the burn rate of $100,000/month, we have 8 months of runway—or eight months til we run out of cash.

$800,000/$100,000 = 8 months

As a rule of thumb, you always want to increase your runway so that your business can survive longer til you reach profitability or can raise money from investors.

You want to have at least 9 months of runway before you start raising money from investors. Because it could take 6 months to find the right investor and maybe another 3 months till the money hits your bank.

Burn rate and cash runway are important metrics for startups. They show how quickly a company is losing money and how long it can continue to do so. This information is helpful for businesses in making decisions about reaching their goals.

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How to use burn rate to determine cash runway?

Burn rate is a key factor in finding out cash runway, or how long your business can survive before the business runs out of money.

The formula for cash runway is:

Cash Runway = Current Cash Balance / Burn Rate

Looking back at our previous example, if our startup has $800,000 in cash remaining and the burn rate of $100,000/month, we have 8 months of runway—or eight months till we run out of cash.

$800,000/$100,000 = 8 months

As a rule of thumb, you always want to increase your runway so that your business can survive longer till you reach profitability or can raise money from investors.

What is a good burn rate?

The burn rate is a measure of how quickly a company spends its cash. If a company burns too much cash, it risks running out of money and going out of business. If a company doesn’t burn enough cash, it might not be investing in its future and may fall behind the competition.

What is a good burn rate? Most entrepreneurs and experts say you should always have at least twelve months of runway. That means your burn rate should be around one-twelfth of your available cash. So if you have $120,000 in available cash, a burn rate close to $10,000 would be good.

A company is said to have a negative net burn rate if it is making more money than it is spending. By measuring the burn rate, you can predict when you will run out of money (if you are spending more money than you are making) or when you will be able to expand. Profitable companies will usually have a negative burn rate because they are making more money than they are spending.

Why Does Burn Rate Matter?

The cash burn rate is especially important for startups and small businesses in the early stages of growth. This is when these businesses are not yet profitable. It may take a few months to a few years to achieve profitability. So, you will need to keep a close eye on your cash and funding to manage expenses.

Many startups take a number of years to become profitable. This is often because they rely on venture-backed investments to help them grow. Often, these startups will go through several rounds of funding, receiving an increased amount of money with each successful round.

Burn rate is a term that investors use to figure out how freely a company is spending its money. If a company spends too slowly, it might seem like they are afraid to invest in the future or that growth won’t happen as quickly as they want. If a company spends too quickly, it might look like the leaders can’t handle money.

Burn rate is a way for startups to plan their financial future. They can see how long they can last with the money they have and when they will need to find new investors. Usually, it takes about 12-18 months to get new funding. So this means that a startup should be able to stay afloat for at least 1-2 years.

Why do VCs keep putting in more money on loss-making startups?

The current venture capital model encourages companies to grow quickly and become popular. This often means spending a lot of money and not being careful with finances.

The main question in the debate is why startup companies that are losing money continue to attract more and more investment from investors. VCs reward these startups for burning through their capital before they earn any profits.

Investors fund startups based on how fast they can grow, not whether they are profitable. As long as it is expected that in the future the company will make a lot of money, choosing not to be profitable now is a strategy. Going for profitability too early often means limiting growth.

The public-listed tech unicorns in the US that are losing money have been doing better than the ones that are profitable. As per the Pitchbook report over the past 9 years, being profitable has barely made a difference in performance.

The end game is, how a startup after raising hundreds of million dollars can disrupt large companies and industries by taking away their market share and better, by creating new markets.

The value of a startup is not based on how much money it has made or lost, but on how much it can grow in the future. Startups that have a lot of ambition and want to grow quickly use venture capital funding to help them do so.

Improving Burn Rate Metrics

If you want your cash burn rate to be lower, the numbers are simple. You need to increase how much money comes in, decrease how much money goes out, or both.

Here are ideas on how to do those things:

Increase revenue

Small and well-established businesses should try to increase revenue instead of reducing costs. This can be done by examining your marketing and sales processes and testing out some new ideas. You can avoid selling assets or cutting expenses if you try this approach.

There are many things you can do to increase your sales. You can get more people to see your product, increase the chances that they will buy it, or charge more for it. When you make more sales, you make more money.

Reduce your payroll expenses

Do you know that salaries and other employee costs account for over 60% of all costs a business incurs? Instead of hiring more people, look at automation and different software tools that can help increase productivity and can do the job better.

For businesses that need to save money, there are a few things you can do. You can delay hiring new people, lay off people who are not essential to the company or limit benefits. However, it is important to make sure any cuts are smart and sustainable.

Study your financial reports

Look over the financial reports from the past few months. See if there were any changes in how much money came in or how much money was spent.

Try to figure out when these changes happened and which parts of the business were affected. Financial reports can tell you a lot if you look at them closely.

Encourage cash sales

Cash sales are a good way to get the money for your home quickly. But you also need to be careful if you’re operating in an industry where credit sales are common. Although cash sales can help you generate more cash, it can reduce your revenues.

Sell assets

Take a close look at your assets. Can you sell any of them for cash? For example, if you have three delivery vans but only need two, consider selling the third. Instead, you can consider renting a third van.

Convert fixed costs to variable costs where possible

Another way to reduce your burn rate is to change your fixed costs into variable costs. This means that you only have to pay for something when you use it.

For example, if you have an office space that you’re not using all the time, you can convert it to a co-working space. This way, you only have to pay for the space when you use it.

You can also convert your office space into an event space. This way, you can rent it out for parties or other events. This can help you generate more cash and reduce your burn rate.

Raise additional funds

If you’ve tried to cut down on your spending and bring in more money, but your business is still losing too much money, you may need to do more fundraising. It’s important to do this as early as possible, since potential lenders may think your business is too risky if it’s running out of cash.

Consider using a factoring service

If you’re having trouble getting customers to pay their bills on time, you may want to consider selling your invoices to a third party. This is called factoring and it can be a great way to get some extra cash quickly.

Reduce direct costs

Direct costs are the costs that you incur to produce your product or service. If you can reduce these costs, it will help you save money.

One way to do this is to use cheaper materials. For example, if you’re selling shirts, you could use a cheaper fabric. Or, if you’re selling software, you could use cheaper hosting.

Another way to reduce your costs is to find ways to be more efficient. For example, if you’re manufacturing products, you could use a faster production process.

You could also reduce your costs by outsourcing some of your work. For example, if you’re developing software, you could outsource the design or testing.

Reduce or defer other expenses

There are other expenses that you may be able to reduce or defer. For example, you could reduce your marketing expenses by cutting back on advertising. Or, you could defer your office rent for a few months.

You may also be able to defer some of your employee costs, such as bonuses or raises. However, it’s important to be careful with this. You don’t want to reduce your employee morale too much.

Pay your bills slowly

If there is no discount for paying sooner, don’t pay your bills any faster than you have to. Take advantage of the time you have to pay to hold onto your cash longer.

You could also try negotiating with your vendors. See if you can get a discount for paying early or on time.

For businesses that are not making money, it is important to know how much money you are spending. For businesses that want to make more money in the future, knowing your burn rate is important so you can plan how to spend your money wisely.

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