The burn rate is the pace at which you are spending down your cash reserves. It is a way for you to measure how fast you are going through your bank balance and can often be used to estimate how long your business has before it runs out of money. There are two different types of burn rates that are both equally important to know: the gross burn rate and the net burn rate.
Calculating Gross and Net Burn Rate
Your gross burn rate is the total amount of money being spent in a certain period. If you have $10,000 of total expenses each month, your gross burn rate is $10,000 because this is your actual cash outlay. Your net burn rate is the amount of money being lost for a certain period. If your total expenses were $15,000 and total revenue was $8,000 for a certain period, your net burn would be a $7,000 loss. If your total revenue was $20,000, you would have posted a profit. Companies that have a positive net income typically do not utilize the net burn rate metric.
Understanding Your Runway
Knowing your burn rate is only useful if you apply your knowledge to long-term planning. You can take your burn rate and divide it by the total cash reserves. This calculation lets you figure out how long your company has to survive on your current bank balance. If your company has a burn rate of $5,000 per month and a cash balance of $75,000, your company can survive for 15 more months before you run out of money.
How to Change Your Burn Rate
You can slow your burn rate by spending less money or increasing revenue. If you shift your expenses to a fixed-cost structure, you increase the risk profile of your company, but this lets you keep more profit as your company expands and decreases your overall burn rate. You can monitor receivables by shorting your payment terms or offering additional ways for vendors to pay. You can also perform cash flow management techniques such as delaying payment debts until immediately before they are due to maximize the amount of interest revenue you may accrue.
Importance of Tracking Burn Rate
If you know your burn rate, you will be better prepared for long-term success. You may have to hold off on large cash outlays if your runway is diminishing. Creditors may not entrust you with loans if your burn rate is too high. Your vendors may tighten credit terms as your burn rate increases to protect themselves from your potential default. Although these are normal business practices, calculating your burn rate and finding your runway period gives you the information you need to plan and increase your chances of having enough cash on hand. Having all of this information starts with you understanding what your burn rate is and how to calculate it.