Accounting & Bookkeeping

How to Calculate Burn Rate

How to Calculate Burn Rate
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A company's burn rate is a calculation at which its cash reserves are depleted. This is known as the burn rate when a business has negative cash flows or is spending more money than it is bringing in. If you're running a loss-making company, monitoring your burn rate can tell you how much longer you can stay in business and help you make strategic decisions about increasing your revenue.

What Is Burn Rate?

Burn Rate
Burn Rate

Your company's burn rate is the amount of money it needs to operate for a given period, often a month. The term "burn rate" describes the rate at which a company expends its available cash.

A company's burn rate is the rate at which it is expected to exhaust its initial funding before turning a profit. Regardless of where they are in the business life cycle, every company may benefit from tracking its burn rates.

When evaluating startups for funding, investors prioritize those with low burn rates, which suggests that their money will go further. Therefore, investments are more likely to pay off for new businesses with a low burn rate since they will grow and become profitable sooner.

Even for mature companies, this measure is crucial. The better prepared you are for revenue declines, the lower your company's burn rate should be. Strong cash flow, as indicated by a low burn rate, is a crucial indicator of a healthy organization. Lack of capital is the most common cause of a company's demise, even when it appears profitable on paper. Keeping your burn rate low is one way to protect your company from this scenario.

Formula

Burn rate can be determined in a few different ways, with some being more involved than others. Let's look at the most straightforward burn rate calculation, but all of them tell you how quickly your organization is depleting its cash reserves.

Monthly Burn Rate = (Initial Cash Final Cash) / Total Number of Months.

How To Calculate Burn Rate?

Calculate Burn Rate
Calculate Burn Rate

You'll need a calculator and the balance sheet for the period in question to determine your burn rate. The following four procedures should next be carried out:

Specify the timeframe over which you will be making your evaluation (burn rate is a current metric, so you want to look at a recent period).

Review your balance sheet (not your bank statement, which will not include uncleared checks or deposits) to determine your cash balance at the beginning and conclusion of the period in question.

To do this, divide your final cash balance by your opening cash balance.

Get an average by dividing the difference by the number of months under consideration.

When calculating the burn rate, you should look at more than just the most recent month's financial data.

In this way, you may keep track of cash outlays and costs that don't come around every month. This will ensure that an exceptionally successful (or bad) sales month doesn't ruin your overall results.

Let's put your newfound knowledge to use by applying it to a real-world scenario.

Example:

Company X is evaluating the burn rate in early April for the first quarter of the year.

On January 1, the first quarter day, Company X had $160,000 in cash. In addition, the company has $100,000 in the bank by the end of the first quarter, March 31.

Initial Funding Needs: $160,000

Final Funds: $100,000

First, subtract the difference between the beginning and ending cash balances from 100.

$160,000 – $100,000 = $60,000

Then, we may evaluate the difference monthly by month. As an illustration, let's use the number three:

$60,000 / 3 = $20,000

For the first three months of 2018, Company X is spending $20,000 per month.

Investors may prefer a net burn rate or gross burn rate figure that excludes capital expenditures. The above computation will provide the data you need to manage your small business's cash flow. It factors in things like interest on loans and owner's withdrawals in addition to the usual operating costs.

How To Improve Burn Rate

Improve Burn Rate
Improve Burn Rate

A company's burn rate can be lowered, and its cash runway lengthened in several easy ways.

Maximize income while keeping costs constant. A higher gross profit margin is the most straightforward approach to boosting earnings without adding to business costs. First, examine your prices to see if there is room for improvement; many small business owners compete based on price when service, convenience, or something else may be more critical to your clients. Possible price increases range from one per cent to three per cent, which might significantly influence your profits while having little to no effect on the amount each consumer spends. If you can increase your company's gross profit margin, you can extend its cash runway and decrease its burn rate.

Cut costs as much as you can. A lot of smaller companies have wasteful expenditures. Examine the expense account for dues and subscriptions first. Do you have any unused subscriptions but keep paying for them? New memberships can build up quickly, even if only $5 to $10 monthly. Ad and marketing budgets are another common area of inefficiency for small firms. You need to spend money on marketing and advertising if you want your company to expand, but you also need to know if those efforts are paying off. You could be wasting money your company needs if you don't know which marketing and advertising efforts are paying off. Examine every expense on your P&L and eliminate the ones that don't contribute to your bottom line or make your company or customers happier.

Think about consolidating debt instead. However, expenses aren't the only thing that might cut into your cash runway. Refinancing may be an option if your debt payments are too expensive for your cash flow. Refinancing debt before you need to is preferable to doing so amid a cash flow emergency.

Plan for stable cash flow by implementing a cash management system. Many entrepreneurs mistakenly believe that achieving a positive cash flow, low burn rate, and a long financial runway is contingent on the company's eventual profitability. Cash management that emphasizes savings and anticipates good cash flow will help you plan for these three. To do this, the Profit Jets cash management system will assist you in setting savings goals, maximizing the benefits of your current spending patterns, and concealing your cash reserves from view until they are needed.