The burn rate is a financial metric that business owners use to measure the amount of money a company spends every month before it generates enough revenue to cover its operational expenses. In other words, it is the pace at which a company uses up its cash reserves in a loss-generating scenario before it generates a positive cash flow.
Many potential investors or venture capitalists use the burn rate as a benchmark indicator to assess business performance and valuation to decide whether or not they will make an initial investment in a particular company.
A high burn rate indicates a negative cash flow, which means that a company is using up resources at a fast rate. This can lead to setbacks such as increased competition, decreased customer loyalty, and an inability to raise additional funding. Conversely, a low burn rate suggests that a business plan and its execution are efficient and profitable.
Burn rate calculation
Companies use different methods to calculate their burn rates. Some use a simple formula that divides the total amount of cash spent by the total number of months it took to reach profitability. Others use a more complex method that accounts for multiple factors such as marketing costs, salaries, rent, or equipment purchases.
Burn rate is an important metric because it helps determine how much money you have left over once you have paid off all your bills.
To calculate your burn rate, start with the balance sheet for the time period you are looking at. From there, subtract the ending balance from the starting balance. Then divide the difference by the number of months.
For example, imagine you want to assess the first quarter of a year. Your starting cash balance on January 1 is $100,000. However, its cash balance on March 31 is $40,000.
Starting cash balance = $100,000
Ending cash balance = $40,000
Then your monthly burn rate would be $20,000 for the first quarter of the year ($100,000-$40,000/3).
4 steps to reduce your company’s burn rate
There are many ways to improve a company’s burn rate, including cutting operating costs, improving efficiency, reducing overhead, raising prices, and offering better products and services. Plus, there are also ways to raise revenues without increasing monthly expenses. Below are four tips for managing your burn rate.
Improve your gross profit margin: make sure that every dollar of sales generates a greater percentage of profits. It is easier to raise your gross margin than it is to cut operating expenses.
Reduce expenses: before cutting basic operating costs such as payrolls, there are several methods you can try beforehand to achieve similar goals, such as spending less money on office spaces or supplies, reducing advertising spending, or identifying unexpected expenses.
Raise your prices: if you are not charging enough, then you will never be able to make a profit. You can start thinking of raising the price of your services or products to get more money back from your customers. One way to do so is by adding extra functionalities to your current offering, as your customers will be willing to pay a higher price for your products or services.
Look at your costs from an outsourcing perspective: if you have outsourced tasks to other companies, you may not realize how much those costs are eating into your profits.
