Burn rate explanation
This rate is used by investors and startup companies to keep track of the amount of cash that a company spends before it starts earning a profit.
The burn rate is normally used to describe the rate at which a new company is spending its capital to finance the overhead before generating a positive cash flow from operations. It is the measure of negative cash flow. And it is quoted in terms of cash spent in a month. This rate is used by investors and startup companies to keep track of the amount of cash that a company spends before it starts earning a profit. It is used as a measuring stick for its runway, the amount of time the company has before it runs out of money. This means that if a company has about $1 million in the bank and spends $200,000 a month, its burn rate would be $200,000 and its runway would be 5 months (got from the formula $1,000,000 / $200,000 = 5).
Note: A company has the power to reduce its gross burn rate or the total amount of operating costs it has every month by generating revenue or by cutting costs, such as reducing staff or seeking cheaper means of production. There are two kinds of burn rates:
- Gross burn: It is the total amount of operating costs that the company incurs in expenses every month.
- Net burn: It is the total amount of money a company loses each month.
In case a technology startup spends $5,000 a month on office space, $15,000 on salaries for its engineers, and $10,000 on monthly server costs, its gross burn rate would be $30,000. If the company was already producing revenue, then its net burn would be different. Even though the company operates at a loss, with revenues of $20,000 a month and cost of the golds sold of $10,000, it would still work to reduce its overall burn to $20,000 ($20,000 – $10,000 – $30,000 = $20,000). This is a very important difference as it affects the amount of money that the company has in the bank and therefore, its financial runway. So, if the company has $100,000 in the bank, its runway would be just 5 months instead of 3 three months. This helps the managers outline the strategy of the company and the amount that an investor would want to invest. Nevertheless, the moment the burn rate begins to exceed the burn forecasts or the revenue fails to meet expectation, the usual recourse is to reduce the burn rate, regardless of the amount of cash in the bank. To know more about the burn rate and any of the other terms, check out our blog or knowledge center here. And if you have not yet started using Eqvista as your cap table application, it’s time to do so. Check out our cap table software here & contact us today!