What is Burn Rate?
Burn Rate describes how rapidly a nonprofitable company is losing (‘burning’) cash per month. This is a KPI often applied to scenarios in science and tech startups, where the new company is operating on venture capital and hasn’t yet turned a profit. Burn Rate is naturally of particular interest for managers and investors alike, as it determines the fledgling company’s ‘runway’ – that is, the amount of time before the company runs out of money.
Burn Rate is an important KPI for your finance team to monitor.
Why is Burn Rate important?
Burn Rate is important because it’s more than a KPI–it’s a measure of fiscal responsibility.
In the early stages of your startup, you’ll almost certainly be operating on limited funds that will run out at some point in the future. It’s your job, and responsibility to investors, to begin producing revenue before you reach the end of the runway.
At the same time, it’s also vital to optimize the funds you do have. This is where Burn Rate comes in: it lets you know how quickly you’re running through much-needed cash, and if to make changes in your expenditures if needed.
How to calculate Burn Rate
Important! There are two ways to calculate Burn Rate. The first, Gross Burn Rate, is simply:
Gross Burn Rate = Total monthly operating costs
The second, Net Burn Rate, takes into account any revenue the company has accrued during the period. Use the second formula if your company is producing revenue even while still on the runway.
Best practices for Burn Rate
An ideal practice to minimize your Burn Rate is to have between 6 and 12 months of funds on hand. As investors will be paying close attention to your company runway in its early stages, demonstrating fiscal responsibility is of utmost importance at this time.
Thus, if it appears that your Burn Rate is shortening your runway too quickly, you’ll have no other choice but to reduce operational costs to avoid the twin pitfalls of debt and investors potentially pulling funding.
In the end, keeping your operational costs low will allow you to not only minimize your Burn Rate and keep your investors happy, but will also help you focus more on positive growth measures, such as Revenue Growth Rate.
Other KPIs similar to Burn Rate include:
