Burn rate measures negative cash flow and is typically quoted in terms of the cash spent by a company per month in relation to the cash available to the company at the start of the period.
How do you calculate burn rate?
- Burn rate is calculated by subtracting a company’s cash balance from its starting balance over a period of time and dividing by that time.
Burn rate is used by companies, often startups, to determine if the amount of money being spent per month is sustainable. This is based on the amount of capital the company has available to it, and if applicable, the amount of revenue it generates. Having control over burn rate is crucial to the success of both established companies and startups and ensures that the company will be able to continue growing at an effective rate. For startups, however, ensuring that they are spending capital effectively is necessary for attracting future investors, and burn rate will often need to be included within any pitch.
To calculate burn rate, a company can review a recent statement, take the account’s beginning balance, subtract the ending balance, and divide by the number of months within the statement period. For example if a company has $3M available at the beginning of the period and has $1.8M at the end of a three month period, the burn rate formula would be ($3,000,000 – $1,800,000) / 3, which would equal a burn rate of $400k a month.
What is a good burn rate?
- Burn rate is completely dependent on each company and the amount of cash required on to operate each month.
There is no exact burn rate figure that will apply to every company, however, there are other metrics that can be used to help a business understand its burn rate and how it plays into the company’s future. One of which is called cash runway, which helps a company understand how long it can continue operating without additional funding at its current burn rate.
The formula for calculating cash runway is the current cash balance / burn rate. So if a company has $8M in the bank and a burn rate of $400k per month, $8,000,000 / $400,000 would give it a cash runaway of 20 months. As the company’s cash balances begin to dwindle, more funding should be acquired. Cash runway and burn rate may fluctuate over time as costs of business evolve and revenue begins to enter.
Is a negative burn rate good?
- Yes, if a company is turning a profit and sees a negative burn rate, it means they are bringing in more money than they are spending.
Burn rate is a useful metric for startups and profitable companies alike, however, for some companies turning a profit, burn rate may provide a negative value rather than a positive. This is due to the company making more money than they spent in the previous period This means their accounts had a lower value at the start of the period than it does at the end of the period. This is the goal for every company as it enters maturity. For example, if a company begins a three-month period with $10M on hand and ends with $16M, the burn rate would be calculated as ($10M – $16M) / 3, which would equal a monthly burn rate of -$2M.
