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Smart spending comes down to knowing and managing your company’s cash burn rate. Below, we’ll explain how to calculate your burn rate, why it matters, and what you need to do to manage your burn for better growth.
Burn rate is the rate at which your company spends money after you consider any influx of cash from earnings. It’s usually referred to as a monthly cash amount. For example, if you’re spending $100,000 per month to stay operational (without making any revenue), your company has a burn rate of $100,000.
The difference between your burn rate and total expenses is the assumed lack of positive cash flow. Your monthly expenses tell you how much you’re spending per month without taking revenue or cash flow into account, but burn rate tells you how much money your company can realistically burn through before you need to start generating positive cash flow.
In other words, your burn rate is usually all negative cash flow.Burn rate also gives you another crucial piece of information: your runway. If your burn rate is $100,000 and you have $2 million in funding, your runway is 20 months. That’s the amount of time you can finance operations before you run out of cash.
A burn rate isn’t a perfect measure of your company’s sustainability; a lot of things go into that, including the market, your business strategy, and your product-market fit. But knowing your monthly cash burn is a really helpful way to track your spending and plan for your next round of funding. Your burn rate effectively tells you:
Burn rate is the rate at which your company spends money after you consider any influx of cash from earnings. It’s usually referred to as a monthly cash amount. For example, if you’re spending $100,000 per month to stay operational (without making any revenue), your company has a burn rate of $100,000.
- How much it costs to finance company operations
- How long you can maintain your current spending before you need more funding
- How much time (and cash) you have to continue experimenting with your product
- How your spending translates to output
- How much revenue you need to bring in to start generating a profit in the near future
Low burn rates are often considered a good thing to aim for—conserve that cash and your company can keep doing business, right? But it’s key to remember that burn rates don’t account for results. If you don’t spend as much as you need to do business, you could fall behind schedule to deliver your product or not be able to market your business effectively.
Instead of trying to keep your burn at an arbitrary threshold, it’s better to focus on knowing what you’re burning and managing your capital wisely—and ensuring your burn rate continues to benefit you. Here are three strategies that can help:
A reliable accounting system is critical to staying on top of your budget and burn rate. Start by hiring an accountant or financial advisor who’s well versed in venture-backed companies. From there, review your income statement, balance sheet, and statement of cash flow every month in detail.
You’ll want to know how much you’re spending on business-critical things such as customer acquisition cost, revenue growth, product features, and shipping speed. All these documents combined will give you a clear picture of what you’re spending, where you’re spending it, and how much cash you have to play around with.
As you start earning revenue or as your revenue grows, your expenses might become more complex. Understanding and tracking your company’s various fixed and variable costs can keep you adaptable as you evolve.
Fixed costs, also known as overhead costs, are costs that stay the same each month regardless of your output or revenue. Your company’s fixed costs might include salaries, office rent, or software subscriptions. Variable costs, on the other hand, fluctuate from month to month; they cover areas like marketing and advertising, inventory, consultant fees, and contractor labor.
It’s a good idea to track both your fixed and variable expenses to see how they’re tied to your company’s growth. As you acquire more customers, for example, you may need to order more inventory, increasing your variable costs. Or you may need to hire another engineer to build out new product features, bumping up your fixed costs.
Regularly reviewing your expenses can tell you whether or not you’re overspending and stretching your burn rate—and if you are, where to cut back. If you can’t afford to scale back on variable costs like marketing, for example, you may have to consider adjusting your fixed expenses, like office rent. Your burn rate (and runway) will change as a result, but that’s OK as long as you’re prepared for the shift.
When your investors ask about your burn rate, what they really want to know is: What are you spending their money on, where is that money taking the company, and when will they see a return on their investment? Put another way: How well are you hitting your targets and maximizing your funding?
If your investors aren’t satisfied with the speed you’re moving at or the decisions you’re making, you may need to rethink your overall burn rate and current cash allocations to make adjustments.
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