Startup Burn Rate
Burn rate is a startup metric used to describe the rate at which a new business is spending money -- usually venture capital -- to finance overhead expenses before reaching profitability. In other words, startup burn rate is the negative cash flow of a business.
Founders and investors look at a startups burn rate for a variety of reasons.
Founders and investors need to determine how long a startup can burn cash before either achieving profitability or running out of money.
It's used to determine when a startup will need to begin raising money.
It enables investors to be able to gauge the level of risk the business is facing.
It enables the startups to respond appropriately to any sudden changes that might hinder continuing operations.
Most importantly, it lets your stay in control expenses so they don’t blow out of proportion.
Different types of burn rate
There are two types of burn rate—net startup burn rate and gross startup burn rate.
Net Burn Rate
Net burn rate is the total amount of money a business to run a business, including cash inflows and cash outflows. Net burn rate subtracts the total revenue from the total amount of money spent in a particular month. If a business’s monthly expenses are $200, 000 and revenues worth $100,000, then the business’s net burn is ($200,000-$100,000) =$100,000.
Gross Burn Rate
Gross burn rate relates to the cash outflows per month. Gross burn rate subtracts the total amount spent in the previous month from the total amount spent in the current month. Then divide the result by the total amount spent in the previous month and multiply by 100 to convert it to a percentage.
If a business spent $100,000 the previous month and $150,000 in the current month, then the gross startup burn rate is (-$50,000).
In some instances, startup burn rate can be misleading, especially when one-off costs are excluded. As a result, it’s advisable to calculate both net startup burn rate and gross startup burn rate to identify any anomalies. It’s also a good idea to dig deeper to establish the percentage of your startup burn rate that corresponds to fixed costs and variable costs. This will help you identify unnecessary expenses that can be eliminated to reduce startup burn rate in case the market dips.
How to calculate a startups runway
To figure out your startups runway, divide the total amount of cash available by the amount you spend every month. If you have $200, 000 in reserves and you burn $25, 000 per month, it means you have 8 months of runway left.
Cash flow best practice for startups
It’s advisable to have at least six months of runway available at all times.
Therefore if your burn rate is $25,000 per month, you should have at least $150,000 in reserves. With adequate runway, you can be able to handle unexpected expenses without threatening the health and success of your startup.