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2016-03-04 00:00:00Money & FinanceEnglishWhat Is A Burn Rate? How Does It Affect Your Business? Gross burn rate vs. net burn rate, Spending vs. hoarding capital, Missed opportunity... Is A Burn Rate? How Does It Affect Your Business?

What Is A Burn Rate? How Does It Affect Your Business?

2 min read

As the term itself suggests, ‘burn rate’ refers to the amount of venture capital that businesses spend on a monthly basis. It is particularly relevant in the case of start-ups since they are still building their business and perfecting their product line. Start-up funds are being expended, but revenues haven’t really started rolling in yet (that will take time).

The adage ‘you have to spend money to make money’ therefore, perfectly captures the formative role that the burn rate plays in the initial stages of a company’s growth and development. It is a metric of how sustainably—or how poorly—this growth is taking place.

Gross burn rate vs. net burn rate

There are two types of burn rate: gross burn and net burn. The difference between the two reflects the success of a company’s business development strategy. Gross burn rate: This is the total amount of money that a company spends each month. Net burn rate: The difference between the gross burn rate and the amount of money a company earns, per month, as a direct result of this expenditure is referred to as the net burn rate.

How these terms apply to business

So, if a company spends ₹100, 000 per month, but earns ₹10, 000, the net burn rate is ₹90, 000. This would count as a loss but is often unavoidable in the early stages of growing a company. Conversely, if the same company were to earn ₹130, 000 that month, the net burn rate would be ₹0—in addition to recuperating their expenses, the company would have also registered a profit of ₹30, 000. A negative net burn rate is by no means a bad thing for a fledgling business.

All it would mean in the initial stages is that money is being invested—as intended—on growth (make money to spend money is the operating principle.) However, if this situation persists over a substantial length of time, it means that the investments aren’t ‘paying off’ in the form of customer demand and adequate sales.

Spending vs. hoarding capital

But that’s further down the road. Assuming that investors expect to see a negative net burn rate at the very beginning of a venture, in the form of losses, does it make sense for companies to actively minimize their losses by holding onto their capital, in order to spend it later, when they’re more ‘stable’ (i.e. finally making money)?

Missed opportunity costs

The answer is generally no. Underspending is as bad as overspending (just like driving too slowly is also a ticketable offense—on par with speeding—in some countries.) Experts argue that not spending money in the present—i.e., not burning through it—could mean that you’re not taking advantage of expensive, but potentially lucrative, situations.

Conserving money now could actually mean a lack of revenue—and not just profits—later. As Goldilocks discovered, there is a fine balance to be struck between too much and too little. To start a fire—just don’t let it turn into a conflagration.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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