Burn rate is one of those words that many entrepreneurs might not understand. This is a term usually used in the startups world (tech focused fast growth companies). That’s why i will try to provide a burn rate definition.
Burn rate, stands for money burning rate, the amount of money operating the company costs each month (after adding revenue).
In a standard business, you would hear of income, sales, gross sales or even top line, but rarely burn rate. The reason for a business to exist, is naturally to make money not lose money. The idea that a business have a monthly losing money budget might be absurd, for a non tech startup.
Yet that’s what burn rate is. Burn rate simply put is the money losing speed a company has. Burn rate is the opposite of monthly income. It is the net total money that is spent by the company per month. This include any revenues made, but due to spending being higher than revenue, the result is usually negative.
How is this possible? Because startups follow another approach to business. Startups have a negative cash flow for many months even years, and they rely on raising funds from investors to finance their operations.
The situation with negative cash flow remains till the product is ready or takes off, and start generating revenue. Once the revenue generated surpasses the expenses we have a positive cash flow. During the entire pre-positive cash flow we say the company have a burn rate.
The burn rate is a measure of negative cash flow. The burn rate is usually quoted in terms of cash spent per month. It is a term to describe the rate at which a new startup is spending its venture capital to finance overhead, before generating positive cash flow from operations.
high-growth industries startups, often take years to become profitable on their own, relying instead on venture-backed investments to fuel their development and growth.
For startups, revenue is not a priority, growth is, thus money is needed in big amounts, and startups will go through several rounds of funding on their road to profitability.
How to Calculate Burn Rate
Burn Rate = (Starting Balance – Ending Balance) / # Months
Gross burn shows how much your business spends on operating expenses alone.
Net burn rate takes revenue into account (if the startup has generated any).
Another important term associated with burn rate cash runway, or how many months your business can continue to operate at that rate before hitting zero dollars in the bank.
Cash Runway = Current Cash Balance / Burn Rate