Today, we are going to talk about burn rate.
Your burn rate is the speed at which your cash balance is going down. For example, if you have $2M cash on 1st January, and now it is 1st October, and you have $1,250,000 left, your burn rate is $750,000/9, or around $83,333 per month.
Understanding the Burn Rate
So, it is 1st October and you have $1,250,000 left and your burn rate is $83,333 per month. How many months of cash do you have left?
Take the amount of cash you have left ($1,250,000) and divide by your burn rate of $83,333 per month. You have about 15 months before you run out of money.
CEOs and CFOs should always know their cash flow at the back of their hand. Investors will certainly be interested to know how much the company is spending on a monthly basis before they generate its own income. It is also used as a measuring stick to determine the runway or the amount of time the company has before it runs out of money.
If your company is highly profitable like Apple, Alphabet or Microsoft, then burn rate is not as important. However, most companies can go from being profitable to losses pretty quickly. The current coronavirus situation in China will most likely have a global impact on supply chain and economic slowdown. Likewise, we see a similar incident in the 2008 Global Financial Crisis 2002 SARS and dot com bubble couple with 9/11 all lead to the credit crunch as business activities slowed.
The above is just a simplistic ‘back of the envelope’ approach to getting your company’s burn rate. The more formal approach will involve looking through your monthly expenses on your income statement, and any other outlays of cash for capital expenditures on the balance sheet and cash flow statement.
High burn rates
High burn rates may not necessarily be bad. It is common during expansion, companies increase their expenditure to capture the market.
This is especially true for startups. Some has negative cash flow for a short time, others a longer period of time. More importantly, during this period, you need to keep a close watch on your cash balance and burn rate.
It will give you an idea when you need to raise money again. VCs and investors will be interested to know the key metrics you used to measure your progress or traction.
We encourage startups to have a very clear idea about this and be prepared to answer them.
- The burn rate is the pace at which your company is running through the capital that you have raised.
- It gives you a good idea of how much time you have before you need to raise capital again.
- Monitor your cash flow and know the key metrics to measure your traction.