Having an optimal burn rate leads to a healthy business- and a healthy business attracts investors. In this article, we’ll give you the a-z breakdown of the burn rate, show you how to calculate it, and give you tips to improve it.
A significant factor to consider, both as a start-up and as a well-established business, is the rate at which money enters and leaves the business. The key to attaining high profitability, as a business is to constantly monitor the inflow/outflow of cash. Most start-ups go out of business because they don’t track their cash flow, and according to a medium article, they lose track and lose the resources necessary to continue funding their operations.
A major calculating criterion to consider in this regard is the Burn rate. Burn rate, however, is only concerned with how much money the business spends during its operation. As a result, its only deciding factor is the company’s negative cash flow. It is important to maintain a low burn rate for your business because having an optimal burn rate leads to a healthy business, and a healthy business attracts investors.
In this article, we will give you the a-z breakdown of the burn rate, show you how to calculate it, and give tips to improve your burn rate.
What is Burn Rate?
Burn rate is the rate at which a business burns its cash monthly. It is the total of the money used to cater to monthly business expenses. These expenses would include rent, costs of operation, cost of goods/services production, cost of maintenance, equipment, and other miscellaneous spending for the business.
Your business’s burn rate could be calculated with the money spent from the starting capital alone or when your business starts generating revenue. As we said earlier, calculating the burn rate is essential for start-ups as well as established companies.
For start-ups, maintaining a low burn rate helps the business in more ways than one, and we will tell you why. One of the criteria investors look at before investing in a new business or product is the business’s burn rate. They love to start at a place where they believe that their money would go a long way and have a high probability of generating profits. To do this, all they have to do is to look at the spending habits of the business, amongst other factors.
Let’s look at other reasons why burn rate is important for your business.
Why is Burn Rate Important?
One of the reasons you should know your burn is that it gives you an insight into how much revenue you need to generate to cover these spending. This is mainly for, but not limited to, start-up companies still in their early phases and have not started generating revenues for the company. Their burn rate informs them of how much they spend monthly and how much revenue they would need to generate for the business to cater to their monthly expenses and to realize their profit.
Another reason to consider is that your burn rate lets you know how much cash your business has left before it runs out. If your company operates with its starting capital, your burn rate would determine how fast the money vanishes. In the absence of cash (without revenue generation), the business has to halt. So, to avoid this, your burn rate would need to influence any financial decisions you need to make to make your capital last longer, at least until the business starts generating its income.
How to Calculate Burn Rate
Gross Burn Rate:
Your gross burn rate would be the total amount of cash that leaves the business at a certain period of time (monthly). This includes the money spent on expenses like paying salaries, rents, and the cost of equipment maintenance.
Gross Burn Rate = Total cash spent on operating expenses in a month
Net Burn Rate:
To calculate your net burn rate, you would find the difference between your business’s expenses and the monthly revenue generated. It is a metric that measures the difference between cash inflow vs. cash outflow.
Net Burn Rate = Cash inflow – Cash outflow
According to Investopedia, the difference between Gross and Net burn rates is that Gross burn is the total amount of operating cost it racks up each month, while Net burn is the total amount of money a company loses monthly.
Example of Burn Rate
Suppose a SaaS startup, P, starts with a capital of $100,000 and spends a sum of $15,000 on rent, $10,000 on equipment maintenance, and $15,000 on salaries. The business then generates revenue of $70,000 at the end of the month. To calculate the burn rate,
Gross Burn Rate = $15,000 + $10,000 +$ 15,000 = $40,000
Net Burn Rate = Revenue generated – Operating expenses = $70, 000 – ( $15,000 + $ 10, 000 + $ 15, 000) = $70,000 – $40,000 = $30,000.
4 Tips to Improve your Burn Rate
Focus on the company’s growth:
A startup business can experience a high/ fluctuating burn rate during the early days of the business. However, as the company begins to experience growth, it can cut back on the amount of cash that the business burns. So, to improve your business’ burn rate, it is crucial to focus on growing your company as it would positively reflect on your burn rate.
Businesses can grow their business by increasing their reach to their target audience. One of the best ways to do this is to adopt a working marketing strategy. Marketing would grant you access to a more extensive customer base, and more customers equal more sales, more sales equals business growth, and eventually lead to a reduction in burn rate.
Another tip to improve your burn rate is to manage your cash transactions effectively. It would help if you spent only on necessities necessary for the smooth running of your business. Try to cut back on expenses that the company can do without, and you should try to maximize your spending and transaction.
Increase revenue, not expenses:
It is important to focus on more ways to generate revenue rather than more ways to spend money. If your business generates more than it consumes, it can balance out the account at the end of the month. The company won’t be at risk of incurring a loss, and you can prevent it from entering the red/danger zone.
Burn Rate in a Nutshell
The total amount of money that your business spends in a given period of time (monthly) describes the burn rate. It is the rate at which your business burns its cash, capital, or revenue. How high or how low your burn rate is will determine how much profits your company yields, and it will decide if it will ever survive or not, among other factors. So, to ensure that the company attains fruition of its purpose in the market, it is vital to keep your head above the waters by keeping your burn rate low.