What is a Burn Rate?

Burn Rate

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Burn Rate

A burn rate is a financial metric that represents the rate at which a company is spending its cash or capital, usually expressed as a monthly figure. It is commonly used by startups and early-stage businesses that are not yet generating significant revenue or profit. The burn rate is a critical measure for these companies, as it helps determine how long they can sustain operations before needing to generate positive cash flow or raise additional capital.

There are two types of burn rate:

  • Gross burn rate: This is the total amount of cash spent by a company per month, including all expenses such as salaries, rent, utilities, and marketing.
  • Net burn rate: This is the difference between a company’s cash inflows (revenue) and outflows (expenses) per month. It gives a better idea of how quickly a company is consuming its cash reserves after accounting for any revenue generated.

Understanding and managing the burn rate is essential for startups, as it provides insights into their financial health, the efficiency of their operations, and the time remaining before they need additional funding or become profitable. A high burn rate may indicate a need for cost-cutting measures or changes in business strategy, while a lower burn rate can signify more efficient use of resources and a longer runway before requiring additional capital.

Example of a Burn Rate

Let’s consider a hypothetical startup called “Tech Innovate.”

Tech Innovate is a software development company that has just begun its operations. The company has raised $1 million in seed funding. It has a monthly gross burn rate of $100,000, meaning it spends $100,000 per month on expenses such as salaries, office rent, utilities, and marketing.

Tech Innovate is generating some revenue, about $20,000 per month. To calculate its net burn rate, we subtract the revenue from the gross burn rate:

Net burn rate = Gross burn rate – Revenue
Net burn rate = $100,000 – $20,000
Net burn rate = $80,000

This means that Tech Innovate has a net burn rate of $80,000, which represents the amount of cash it consumes per month after accounting for the revenue generated.

Now, let’s determine how many months Tech Innovate can sustain its operations with the initial seed funding:

Runway = Initial funding / Net burn rate
Runway = $1,000,000 / $80,000
Runway ≈ 12.5 months

This means that Tech Innovate has approximately 12.5 months of runway before it runs out of cash, assuming its burn rate and revenue remain constant. Tech Innovate should closely monitor its burn rate and make adjustments to its operations or strategy if necessary to avoid running out of cash before it can generate sufficient revenue or secure additional funding.

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