What is Burn Rate?
The Burn Rate measures the rate upon which a company spends its cash (i.e., how quickly a company is spending, or “burning,” its cash). In the context of cash flow negative start-ups, the burn rate measures the pace at which a start-up’s equity funding is being spent.
How to Calculate Burn Rate (Step-by-Step)
The burn rate metric indicates how long a start-up has until its operations can no longer be sustained, and more funding becomes necessary.
Using the burn rate, the implied cash runway can be estimated – in other words, the number of months that a business can continue operating until it runs out of cash.
To sustain operations, the start-up must either become profitable or, more commonly, raise equity financing from outside investors before the cash on hand runs out.
Since it could take up to several years for the start-up to turn a profit, the burn rate provides critical insights as to how much funding a start-up will need, as well as when it will need that funding.
By tracking the metric, a management team can quantify the number of months they have left to either turn cash flow positive or raise additional equity or debt financing. In particular, the metric is closely tracked by early-stage start-ups that, in all likelihood, are operating at steep losses.
Burn Rate Formula
Broadly, there are two variations of the burn rate metric:
- Gross Burn → The calculation of the gross burn only takes into account the total cash outflows for the period into consideration.
- Net Burn → In comparison, the net burn takes into account the cash sales generated – therefore, the outflows are net against the cash inflows from operations in the same time period.
The formula for the burn rate is as follows.
Conceptually, the gross burn is the total amount of cash spent each month, whereas the net burn is the difference between the monthly cash inflows and cash outflows.
Implied Runway Formula
The calculated rates from above can be inserted into the following formula to estimate the implied cash runway, which, to reiterate, is the number of months a company has left until the cash balance drops to zero.
Why the Cash Burn Rate Matters for Startups
The reason these concepts hold such high importance to venture investors is that nearly all early-stage companies fail once they spend all their funding (and existing and new investors are not willing to contribute more).
Furthermore, no investment firm wants to be the one attempting to “catch a falling knife” by investing in a high-risk start-up that will burn through the cash proceeds from the investment only to call it quits soon after.
By understanding the spending needs and liquidity position of the start-up, the financing requirements can be better grasped, which leads to better decision-making from the perspective of the investor(s).
An important distinction is how the metric should account for only actual cash inflows/outflows and exclude any non-cash add-backs, i.e. a measurement of “real” cash flow.
The resulting runway estimation is thereby more accurate in terms of the true liquidity needs of the start-up.
Putting this all together, by tracking the monthly cash burn, the start-up benefits by gaining insights on:
- Spending needs to plan ahead of time for its next round of funding
- The costs associated with financing operations (and the revenue level that must be brought in to begin generating a profit – i.e., the break-even point)
- The number of months the current level of spending can be maintained before needing more funding
- Or for seed-stage companies, how long the company has to work on product development and experiments
- Being able to compare the spending efficiency and see how it translates to output
Hi what’s the calculation for cash runway for a listed company with fcf?
Burn rate = operating cash flow – maintenance capex
So cash runway = current cash balance and debt balance / burn rate = xx years?