It’s tempting to write off “burn rate” as cute startup jargon or a funny subplot on the television series “Silicon Valley.” But a correctly calculated burn rate is crucial for the responsible growth, planning, and success of a business.
In fact, 82% of small businesses fail because of cash flow problems. But what exactly is a cash burn rate and how do you calculate it? I’ve got the answers for you below.
What is cash burn rate?
Cash burn rate, or negative cash flow, is the pace at which a company spends money -- usually venture capital -- before reaching profitability. It’s often calculated by month (e.g., a startup with a burn rate of $30,000 a month is spending $30,000 a month) and is spent on overhead expenses.
A company’s gross burn is the total amount it’s spending on operational expenses each month (with the absence of positive cash flow). In our example above, a startup spending $30,000 a month on staff salaries, office space, and a cool new ping pong table would have a gross burn rate of $30,000 per month.
Let’s say, however, this company is also generating $5,000 a month in revenue. To calculate the net burn rate, you’d subtract $5,000 from $30,000 for a net burn rate of $25,000 per month.
How to calculate your burn rate
To identify how long your company can burn cash before needing to turn a profit (i.e., running out of cash), divide the amount of cash you have left by how much you spend every month (i.e., the cash you burn). If you burn $25,000 per month and have $100,000 left in reserves, you have four months of runway left.
Most investors and entrepreneurs recommend having at least six months of runway available at all times. That means if your burn rate is $25,000 per month, you’d want to have at least $150,000 in available cash.
This ensures that if there’s a temporary market downturn, a problem with one of your product releases, or an unexpected expense, you’ll be able to handle it without threatening the health and success of your business.
Have more questions about growing a healthy business? We’ve got answers. We also have a helpful guide for all newbie entrepreneurs. Whether you’re currently getting a new venture off the ground or are planning for your future, learning good business practices should always be an important part of your daily routine.
Originally published Oct 12, 2018 7:30:00 AM, updated October 12 2018