What is burn rate?
Burn rate is an important metric that measures how quickly a company is spending its capital, typically expressed as the amount of money that a company spends per month – indicating a negative cash flow. Or as the name suggests, it measures how quickly a company is spending, or “burning” its cash.
Burn rate is an important metric for startups and other companies that are in the early stages of growth, as it can provide insight into the company's financial health and its ability to generate revenue and cover its expenses.
How to calculate burn rate?
It is possible to calculate the burn rate in more than one way. To calculate the monthly burn rate, subtract ‘ending cash’ from ‘starting cash’ and divide this number by the ‘number of months’.
Another way to calculate the burn rate might be — to divide your monthly expenses by your current cash balance and multiply by 100 to get a percentage.
Formula for calculating burn rate
Real-life example of burn rate
Let’s say you run a business and want to review your burn rate for the first quarter of the year. Your cash balance on January 1 (starting cash) was $160,000. And your cash balance on March 31 (ending cash) was $100,000. And as you’re calculating the burn rate for a quarter, the number of months will be 3.
Now, your burn rate will be: (160,000 - 100,000) / 3 = $20,000. This means, your company spent $20,000 each month in the first quarter.
What’s considered a good burn rate? (benchmark)
A good burn rate is around one-twelfth of your available cash. Most entrepreneurs and experts recommend having a burn rate that ensures at least six of runways at all times. Of course, the burn rate will depend on your company's industry, stage of growth, and business model.
In general, a lower burn rate is considered to be better, as it indicates that a company is spending less of its capital each month and has a greater ability to generate revenue and cover its expenses.
High burn rates can be a warning sign that a company is spending too much money too quickly, and may not have sufficient funds to continue operating at its current pace.
Ways to reduce your burn rate
- Cut unnecessary expenses: Take a close look at your budget and identify areas where you can reduce or eliminate expenses. For example, you may be able to cut back on travel or entertainment costs. Read: 50 Ways to Cut Down Your Business Expenses
- Increase your revenue: If possible, try to increase your revenue by finding new customers or selling more to existing customers. This can help offset any reductions in spending and keep your burn rate under control.
- Consider seeking funding: If you're running a startup, you may be able to secure additional funding from investors. This can help provide a cushion to help you reduce your burn rate. But it is recommended to implement only if all your other efforts have gone in vain, since a business running low on cash may strike potential lenders as too risky.