What does ‘burn rate’ mean?
A company’s burn rate is the difference between its gross revenue collected and operating expenses, and is a term commonly used when referring to companies who have not yet reached profitability. It is typically calculated on a monthly basis. When a company has a burn rate above $0, that means it loses money or is cash flow negative. For example, if a company has a burn rate of $2.5 million, the company is losing $2.5 million per month.
Why is understanding your burn rate important?
Understanding burn rate is important, because a company cannot lose money indefinitely. If the company burns through all of the cash on its balance sheet, and can’t raise additional capital, it’ll be forced to shut its doors. As discussed below, a company’s burn rate and runway are directly correlated—the larger the burn, the smaller the runway (all things constant). Together these two metrics paint a picture of how long the company can continue to operate before running out of cash.
Having a high burn rate when a company is growing is common. However, if the burn rate begins to exceed burn forecasts, or revenue fails to meet expectations, the typical recourse is to reduce burn to stretch runway – giving the company a better chance at reaching a breakeven point. If the number of months required to get to breakeven is greater than cash runway, the company will need to either raise additional cash for the balance sheet or continue to trim burn.
That said, depending on the makeup of the company's expenses, trimming burn can mean eliminating the business lines (marketing and sales) that generate revenue. This could further exacerbate the burn rate and create a downward spiral. Your best bet is to focus on shrinking burn over time to allow revenue to outpace expenses and become cash flow positive.
What is the importance of burn rate in Venture Capital?
Venture Capitalists use a company’s burn rate, in conjunction with its growth rate and a number of other factors to determine the performance and invest-ability of a business. In general, investors will shy away from companies with a high burn rate and a low growth rate.
They typically seek out companies that either have a low burn rate and a high growth rate, or a balanced growth and burn rate. This is because companies with a low or moderate burn rate and a high rate of growth are more likely to become profitable and yield a return on their investments.
What are the implications of having a high burn rate?
Having a high burn rate suggests that the company is quickly depleting its cash reserves. As mentioned above, this is sometimes okay so long as the company is growing revenues at an even faster rate or if the company is confident in its ability to raise more capital before running out of cash.
If growth slows and burn remains constant, investors will likely either set more aggressive deadlines to realize revenue, require lower burn targets for the company, inject more cash into the business to provide more time for it to realize revenue, or all of the above.
How to calculate your burn rate?
Calculating your burn rate is simple:
- Define the period in which you want to calculate your burn - typically monthly
- Determine your cash balance at the beginning and end of said period
- Subtract your ending cash balance from your beginning cash balance
- Divide the difference by the number of months you’re analyzing
Example of burn rate calculation?
Let’s say a company has monthly revenues of $100,000. It spends $75,000 each month on salaries, $25,000 each month on rent, $10,000 on software and $15,000 on marketing.
The company’s monthly cash outflows and its burn would be the same and would be equal to: $25,000/mo ($100,000 - $75,000 - $25,000 - $10,000 - $15,000).
If the cash outflows vary each month, then the burn would be the average over the period. E.g. $25,000 outflow in January, $20,000 in February, $40,000 in March => the resulting burn rate over the period would be $28,333.33/mo.
Difference between gross burn rate and net burn rate?
Gross burn rate is a measure of a company’s operating expenses, while net burn rate is a measure of a company's loss each month.
What is the average burn rate of an early stage company?
There is no average burn rate of an early stage company, as it's entirely dependent on its business model, growth rate, industry and more. For example, some startups in biotech burn tens of millions of dollars before they are revenue positive. While other food and beverage startups may be revenue positive from day one.
That said, if a start-up is burning cash at a concerning rate, there should be positive signals justifying the ongoing spending. E.g. exponential revenue or user growth. Typically investors will continue to fund a company, so long as the startup still has a high upside potential and the risk/return profile is not so far out of balance.
What is the relationship between burn rate and runway?
The burn rate and runway of an organization are directly related. The greater the burn rate, the lower the runway and vice versa. This is because cash runway is a measure of how long the cash balances will last at the current cash burn rate. The higher the cash runway—or the lower the burn rate of a business—the more likely it is that it will reach its break even point and survive.
To calculate the cash runway of your business, divide your current cash balance by your burn rate. For example, company XYZ has a burn rate of $10,000 a month and $100,000 in cash in the bank, all things constant, the company has 10 months of runway remaining. Ideally you’ll want to start fundraising before you have 6-8 months of runway remaining.
We’ve outlined some tactics to reduce your burn rate below, which as mentioned above, will subsequently increase your runway (assuming your revenue stays constant).
How do I improve my burn rate?
Improving the burn rate of a business is simple to explain, but difficult to execute. You’ll need to either scale back expenses or increase your revenue, regardless of what you chose to do, both take time. Ultimately, the best strategy to improve your burn rate is to do both simultaneously. We’ve outlined a fairly simple process below along with some areas to consider making cuts to help you improve your burn rate.
Process to implement to improve your burn rate
- Have your finance team pull together reports of the high level business metrics along with line by line items for each department. Look at the metrics of each of the revenue centers and how their results have been trending over time. Then look at the expenses. You’re looking for expenses that have trended higher over time without measurable impacts to revenue. You’re also looking for unexplained dips in revenue.
- Gather more information from leaders. Interview your business line leaders to understand what is causing the dips in revenue or increases in expenses. Is it underperforming team members, have your cost of goods sold gone up, have the market dynamics changed?
- Dive into the weeds. Now that you’ve discussed the high level themes with your leadership team, talk directly with the individuals who interface with your customers and dive even deeper into the financials. What are the specific items that are driving up your expenses? What are your front line employees seeing, hearing, noticing? Are there new objections coming up? Is your pricing model still competitive?
- Create a plan, get feedback and make adjustments. Based on the new information you’ve gathered, form hypotheses and put together an action plan. Share said plan and gather feedback from your leadership team, then make adjustments.
- Create forecasts based on the plan. Share your plan with your finance team to come up with new spend projections and forecasts around your burn rate and your runway.
- Inform the team. Now that you have finalized plans and forecasts to back them up, share them with your team. They’ll likely have questions—answer them. Spend as much time as needed to make sure that everyone understands what is happening, why this plan is necessary, and exactly what impacts you expect it to have based on the forecasts.
- Execute the plan. Empower every member of your team to act out the plan—give them the necessary tools, information and confidence they need. Provide channels for them to communicate progress and feedback as the plan roles out.
- Measure and make changes on the fly. As with most plans, you will likely get an item or two wrong. For whatever reason, if they don’t work, you’ll need to be prepared to make changes on the fly. To track the effectiveness of your plan, have weekly (or daily) meetings with your finance team and business leaders.
- Last resort. Ideally the plan you come up with following the steps above starts turning your business around. If this doesn’t happen and you have less than 6 months of runway remaining with no line of sight into raising additional capital, your last resort (and we mean last resort) is to conduct layoffs.
Areas to cut costs to improve burn rate
- Software subscriptions - In fast-growing organizations, there is a high likelihood that there are redundant technology accounts across departments. Maybe a team member signed up for an additional project management software or web analytics tool when there was already an active subscription in place. Optimize active subscriptions by looking for duplicate seats. Once you’ve cut back here you can start auditing your tech stack for redundant solutions that your team doesn’t have a need for.
- Pause new hires - Implement a hiring freeze while you conduct a thorough analysis of your business and try to correct the course. Make it clear that you will fulfill offers that were already accepted, but you will not be issuing any new offers for the time being.
- Unnecessary benefits - Some benefits provided by companies are necessary to retain talent—health care coverage, 401k plans, flexible PTO…etc. Others, such as health and wellness stipends, daily catered lunches, and company retreats are “nice-to-haves” and maybe not as essential and could be cut. Before you take away any company benefit (big or small) , we strongly recommend that you inform your employees and let them have a say in what gets cut first.
- Advertising budgets & excessive marketing spend- investing in advertising and marketing will help drive your revenue goals but that doesn’t mean you can’t sunset campaigns that are underperforming. Consider cutting exploratory channels first and fast following with ones that are underperforming.
- External agencies - Oftentimes fast growing companies outsource elements of their business–these can include outbound & prospecting sourcing, recruiting agencies, call centers, pr & comms firms, media agencies, SEO agencies, web design and development agencies, and more. While these contractor agencies typically have locked in terms, there is a strong likelihood that if you explain your financial situation, you can reduce the recurring expenses at a minimum or completely eliminate them altogether.
- Unprofitable product or service lines - oftentimes companies offer loss leaders to attract new customers into the pipeline. If you offer loss leaders, consider raising the prices or getting rid of them all together.
- Current debt. If you have short term debt on your balance sheet and the payments are high, consider refinancing it into more longer term debt forms. It’s best to refinance debt before you need to—don’t wait until you are already experiencing a cash flow crisis.
There is one other area that you can cut costs, but it should be your absolute last resort—headcount of your full time (or part time) staff. For most companies, payroll is the largest portion of burn, so taking a measured and considerate approach to reducing this line item is crucial. Review our guide on a “reduction in workforce” here to learn about the human centered approach to layoffs.
How to increase your revenue to reduce your burn rate
Increasing your revenue is great, but if it increases your expenses proportionately then it's a zero-sum game. The only way to reduce your burn by increasing your revenue is to keep your expenses consistent or increase expenses by an amount less than your revenue. The easiest way to increase revenue without increasing expenses is to improve your gross profit margin.
There are many ways to improve your gross margins depending on your business model, but the simplest is to raise your pricing or change your pricing model. A 1% to 3% raise could have a considerable impact on your margins while having a minimal effect on your conversion rate. Note: if you raise prices too much you'll become non-competitive, so be very strategic.
Key consideration: If you are considering implementing a large price hike, say 10%, it's likely best to do it in one tranche rather than over time. If you inform your customers about why you made the change, most will likely understand and continue the relationship. The rest, who are price conscious, will move on but you likely would’ve lost them regardless of whether you made a 3% or 10% increase.
Our thoughts on the burn rate of a company
Most venture-backed early stage companies burn money each month. Speed is a startups’ number one competitive advantage, and that often implies burning cash on the road to eventual profitability. The best companies don’t just forecast revenue, they also plan for burn, and stick to a tight budget to maintain a healthy runway. It's a lot easier to cut your burn when it's ten or twenty thousand dollars a month, rather than hundreds of thousands or millions of dollars.
For revenue-generating companies that have 6+ months of runway remaining, a great alternative to venture debt or venture capital is revenue based financing (RBF). With RBF, companies can recognize their future revenues upfront and receive access to capital the same or next day. RBF is best used in tandem with cost cutting to extend a startups runway in the event that they’re running low on cash.