How to Calculate Cash Burn Rate and Startup Runway
Enter your organization’s cash balances from the past three months to determine the burn rate and cash runaway.
The cash burn rate assesses how rapidly an organization “burns” through or loses money. This is most practical for venture-backed businesses and startups as they may be investing more money back into their business than they are earning, operating at a loss intentionally.
The benefit of the cash runway calculation is that you can recognize how much longer you can operate at this rate until you run out of money.
To determine your cash burn rate, you need to assess your cash balances over some time; ideally, you can find this information on previous cash flow statements. Let’s say we want to determine the burn rate for a quarter’s spending; using the burn rate calculator, we would take the beginning cash balance of the stated quarter, the balance at the end of the quarter, and the number of months (which in this case is 3).
The number provided is the rate at which your cash is depleting. The rate will be negative if you earn more money than you spend.
How to Calculate the Burn Rate
The burn rate calculation is straightforward, even more so with a cash flow statement. The formula is as follows: Burn Rate = (starting balance - ending balance) / # of months
It is vital to select a long enough period to produce an accurate average when determining the burn rate. Giving data from only two months, possible fluctuations in spending may result in an inaccurate measure of how quickly money is being spent.
Say you spend $50,000 in one month and $150,000 in the following two months, calculating the burn rate from the first month alone would give an inaccurate measure of how long your money would last for. This is why it is imminent to recalculate the burn rate each month and use a substantial period length to guarantee accuracy.
There are alterations in the burn rate measurement that allow you to gain more insight into your spending.
The gross burn measures how much of your spending is towards operating expenses. Included in operating expenses are payroll, rent, and taxes. The gross burn counts on the assumption that the business has a negative cash flow. Say a company spends $60,000 on payroll, rent, and utilities, then the gross burn rate would be $60,000.
The net burn metric accounts for revenue, in the case your business has earned some but focuses on one month. To do this, subtract revenue from spending and expenses accumulated throughout the month. The amount left over is how much money was lost within the month.
Some investors choose to review this metric when determining whether or not to invest in an organization. Although, many owners that attempt to understand the health of their finances tend to measure and analyze the cash burn rate.
Why Does Burn Rate Matter?
The burn rate is an essential indicator for both startups and established companies to monitor regularly. Startups should do this in order to ensure that investors’ money is put to good use, whereas established companies or small businesses use this metric to stay afloat.
Startups and Burn Rate
Startups, particularly those in high-growth industries, typically take years to become profitable on their own. In the meantime, they rely on venture-backed investments to stimulate their growth and development. Startups normally go through many rounds of funding before sustaining profitability on their own. Between investment rounds, they’ll begin spending money to yield growth and profitability in the future. The amount of spending and saving varies from startup to startup, cut investors keep a close watch.
Burn rate indicates to investors whether a business is too free or too constrained with its spending. If a company spends too slowly, it signals that they are unlikely to invest aggressively, and future growth may not progress as rapidly as they desire. On the other hand, spending too freely causes investors to have a lack of confidence in the leadership ability to consciously manage funds.
Furthermore, the burn rate helps startups determine a plan as to when they need future funding. The average time period between gaining funds often is 12 to 18 months, so each new round should support the startup for 1 to 2 years at the least. Note that it occasionally takes about 6 to 9 months for a startup to secure funding. Once funding is confirmed, they would need to begin searching for funding opportunities a few months later. The burn rate indicates when new funding is required.
Established Businesses and Burn Rate
For businesses who do not seek venture capital funding are advised to keep watch on their burn rate, should they be operating at a loss. The burn rate and cash runway help these businesses determine how long they can work at a loss until they are required to shut down. Moreover, it allows them to understand the urgency of searching for a solution to increase their revenues.
Improving Burn Rate Metrics
1. Understand the business’ financial reports
Collect the financial reports from the last couple of months and take some time to understand them. Look to see if there are changes in revenue or spending. Try to narrow on what happened and to which area of the business. Financial reports reveal significant and substantial amounts of information when understood accordingly.
2. Minimize costs
Particularly for startups, this step is the most effective to adjust the burn rate. Look to the cost of goods sold and operating expenses to find unnecessary outflows that can be removed.
3. Sell assets
Review your assets to determine if there are any that can be liquidated to increase cash on hand, thereby increasing the burn rate.
4. Increase revenue
Finding ways to increase revenue is a more sustainable solution rather than solely reducing costs.
Utilizing Burn Rate to Calculate Your Cash Runway
To determine your cash runway, the burn rate is required. The cash runway is a metric to show how long a company can remain in business before reaching $0.
The formula for cash runway is as follows: Cash Runway = current cash balance/burn rate.
The burn rate and cash runway go together for startups. Collectively, these calculations give businesses a holistic view on how quickly they will run out of money, for how long they will continue to do so, and whether they are required to make adjustments to reach their goals.
Knowing Your Burn Rate
For businesses who are not earning a profit, the cash burn rate and cash runway are resourceful and essential metrics. Conversely, for startups, understanding and monitoring the burn rate is vital in determining your spending strategy and achieving your goals.
SRJ Chartered Accountants works with many small business owners to establish optimal business structures to reduce taxes paid at the corporate and individual levels. If you have any questions or want to connect with an Accountant, please feel free to contact our offices at email@example.com or by phone at 647-725-2537.
Frequently Asked Questions
The formula is as follows: Burn Rate = (starting balance – ending balance) / # of months
You can also use the calculator provided above.
The formula is as follows: Cash Runway = current cash balance / burn rate.
You can also use the calculator provided above.
Burn rate can be calculated in excel using the following formula: Burn Rate = (starting balance – ending balance) / # of months.
The monthly burn rate is the burn rate that is calculated for each month.
A high burn rate indicates that a company is using up its cash supply at a rapid rate. It stipulates that the company has a higher likelihood of a financial crisis.