Burn Rate: What It Is and How to Calculate It

This content has been reviewed and edited by an Investment Advisor Representative working for Global Predictions, an SEC-registered Investment Advisor.

Burn rate is the rate at which a company spends its cash to cover monthly operational expenses. This concept is relevant for businesses across various sectors and stages, as it helps to gauge financial sustainability over time and facilitates strategic planning.

Key Takeaways:

• Types of Burn Rate: Burn rate can be gross (expenses only) or net (expenses minus revenue), providing complementary perspectives on cash consumption.
• Importance of Burn Rate: It tracks financial health and calculates the “runway,” or remaining operational time before cash is depleted.
• Control Strategies: Cost reduction, revenue diversification, and adjustments to financial projections are ways to manage and optimize burn rate.
• Additional Indicators: Metrics like the Burn Multiple offer a more comprehensive view of financial efficiency, helping align cash consumption with growth.

Types of Burn Rate

There are two main types of burn rate: Gross and Net. Each provides a specific view of a company’s cash consumption.

• Gross Burn Rate: Measures total monthly expenses before considering any revenue. This figure helps understand the total expenditure without revenue offset.some text
  • Formula: Gross Burn Rate = Total monthly expenses
• Net Burn Rate: Reflects the actual monthly cash loss after accounting for revenue. This value represents the net impact on cash and is useful for calculating the “runway.”some text
  • Formula: Net Burn Rate = (Expenses - Revenue) per month

Why Is Burn Rate Important?

Burn rate is essential for evaluating the financial health of any company that isn’t yet fully self-sustaining in terms of cash generation. It enables managers and investors to assess cash efficiency and calculate the remaining operational time (runway) before additional funding is needed or operational adjustments are required.

• Runway (Operational Time): Calculated by dividing available cash by the net burn rate, runway indicates how long a company can operate at its current cash consumption rate without needing additional funding.

Practical Burn Rate and Runway Example in Different Sectors

To better illustrate, let’s consider two scenarios: a tech startup and a traditional retail company.

Tech Startup:

• Available Cash: $500,000
• Total Monthly Expenses: $90,000
• Monthly Revenue: $20,000
• Net Burn Rate: $70,000 ($90,000 - $20,000)
• Runway: $500,000 ÷ $70,000 ≈ 7 months

Due to high investment in research and development, the startup has a shorter runway, indicating a need for additional funding sooner.

Retail Company:

• Available Cash: $500,000
• Total Monthly Expenses: $70,000
• Monthly Revenue: $50,000
• Net Burn Rate: $20,000 ($70,000 - $50,000)
• Runway: $500,000 ÷ $20,000 = 25 months

The retail company has a longer runway due to more consistent revenue, offering more time for adjustments and a steadier pace of expansion.

Strategies to Control Burn Rate with Practical Examples

Reducing Non-Essential Costs:

Supplier Negotiation: Reducing costs by renegotiating terms or volume can help. Example: A software company could negotiate lower licensing fees with suppliers.

Low-Cost Marketing Tools: Small businesses can reduce advertising costs by focusing on social media and organic digital marketing strategies, such as SEO.

Expanding Revenue Streams:

New Products or Services: Offering complementary products or services can boost revenue quickly. Example: A fashion e-commerce business might expand into seasonal accessories, generating extra income.

Strategic Partnerships: Collaborations with related industries can broaden reach and attract new customers. Example: A health app could partner with a pharmacy chain to promote products.

Reviewing and Updating Financial Projections:

Regularly revisiting projections, ideally quarterly, allows companies to adjust their burn rate in response to market changes. For instance, a company in an expansion phase may re-evaluate sales and expense targets to better align cash forecasts and runway.

Additional Metrics: Burn Multiple and Other Efficiency Indicators

Beyond burn rate, the Burn Multiple is a valuable metric for investors, as it measures growth efficiency relative to cash consumption. Calculated by dividing the burn rate by revenue growth, this ratio helps assess whether capital is effectively driving growth. A low Burn Multiple indicates efficiency, whereas a high value could signal excessive cash usage relative to growth.