What is Burn Rate?
The Burn Rate is the rate at which a company spends its cash, most often used to analyze the spending of early-stage start-ups. 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.
Table of Contents
- How to Calculate Burn Rate
- Burn Rate Formula
- Why Does the Burn Rate Matter for Startups?
- How to Interpret Burn Rate?
- What is a Good Cash Burn Rate?
- SaaS Start-Up Burn Rate Calculation Example
- Burn Rate Calculator
- 1. Early-Stage Startup Operating Assumptions
- 2. Gross Burn Rate Calculation Example
- 3. Net Burn Rate Calculation Example
- 4. Implied Cash Runway Analysis
How to Calculate Burn Rate
Given 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, including 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, early-stage start-ups closely track the metric that, in all likelihood, are operating at steep losses.
Burn Rate Formula
Broadly, there are two variations of the burn rate metric:
- Gross Burn Rate → The calculation of the gross burn only takes into account the total cash outflows for the period.
- Net Burn Rate → In contrast, 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 gross burn rate formula is simply equal to the total monthly cash expenses of the startup.
In contrast, the net burn rate formula is equal to the difference between the total monthly cash sales and total monthly cash expense of a startup.
Conceptually, the gross burn is the total amount of cash spent each month, whereas the net burn is the difference between monthly cash inflows and cash outflows.
The burn rate of an early-stage company (i.e. start-up) is most often measured as part of analyzing its implied runway.
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.
Implied Runway = Cash Balance ÷ Burn Rate
Why Does the Burn Rate Matter 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).
Further, no investment firm wants to attempt 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 therefore more accurate in terms of the true liquidity needs of the start-up.
Therefore, 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
How to Interpret Burn Rate?
If a start-up is burning cash at a concerning rate, there should be positive signals supporting the continuation of the spending.
For example, exponential user growth and/or promising product features in the pipeline soon to be introduced could potentially lead to better monetization of the customer base – which will be reflected in the LTV/CAC ratio.
A rapid pace of burn is not necessarily a negative sign, since the start-up might be operating in a competitive industry.
Investors are willing to continue providing funding if the product concept and market are deemed lucrative opportunities and the potential return/risk trade-off is considered worth taking a chance on.
While an unsustainable rate over the long run can become a cause for concern to management and investors, it ultimately depends on the given company’s specific surrounding circumstances.
By itself, the cash burn rate is neither a negative nor a positive indication of the future sustainability of a startup’s business operations as a standalone metric.
Thus, it is important not to view the rate as a standalone metric when evaluating start-ups, since the contextual details can provide more insights into the reasoning for the high spending rate (and if additional funding rounds are on the horizon).
What is a Good Cash Burn Rate?
A typical start-up will begin raising additional funding from new or existing investors when the remaining cash runway has fallen to approximately 5 to 8 months.
Given the amount of funding raised in the previous round, the $10mm, running out of cash in one year is considered fast. On average, the time between raising a Series B and Series C round ranges between ~15 to 18 months.
However, note that this entirely depends on the context of the start-up (e.g., industry / competitive landscape, prevailing funding environment) and is therefore not intended to be a strict timeline that all start-ups follow.
For instance, a start-up that does not expect to run out of cash for more than two years with significant investor interest could raise its next round of financing six months from the present day, despite not actually requiring the cash.
SaaS Start-Up Burn Rate Calculation Example
Suppose we’re tasked with calculating the burn rate of a SaaS startup using the following assumptions.
- Cash and Cash Equivalents: A start-up currently has $100,000 in its bank account
- Cash Expenses: The total cash expenses each month are $10,000
- Net Change in Cash: At the end of each month, the net change in cash for the month is $10,000
By dividing the $100,000 in cash by the $10,000 burn, the implied runway is 10 months
- Implied Runway = $100,000 ÷ $10,000 = 10 Months
Within 10 months, the start-up must raise additional funding or become profitable, as the assumption here is that the monthly performance remains constant.
Note, that there were no cash inflows in the example above – meaning, this is a pre-revenue start-up with a net burn that is equivalent to the gross burn.
If we assume the start-up has monthly free cash flows (FCFs) of $5,000, then:
- Cash Sales: The $5,000 in cash sales is added to the $10,000 in total cash expenses
- Net Change in Cash: The net change in cash per month is cut in half to $5,000
Upon dividing the $100,000 in cash by the $5,000 net burn, the implied runway is 20 months.
- Implied Runway = $100,000 ÷ $5,000 = 20 Months
In the 2nd scenario, the company has twice the number of months in cash runway because of the $5,000 in cash inflows coming in each month.
Burn Rate Calculator
We’ll now move to a modeling exercise, which you can access by filling out the form below.
1. Early-Stage Startup Operating Assumptions
Suppose we’re tasked with measuring the burn rate and implied runway of an early-stage start-up, with $500k in existing cash on hand and $10 million in funding raised from venture capital (VC) firms.
In the first step, we must calculate the “Total Cash Balance” line item, which is simply the existing cash on hand plus the funding raised.
- Existing Cash-On Hand = $500k
- Funding Raised = $10 million
- Total Cash Balance = $500k + $10 million = $10.5 million
In this scenario, we assume the start-up had $500k in its bank account and just raised $10mm in equity financing – for a total cash balance of $10.5mm.
Note: The cash balance is assumed to be the amount on hand at the beginning of the period.
2. Gross Burn Rate Calculation Example
Next, the remaining operating assumptions are that the start-up has the following cash flow profile:
- Monthly Cash Sales: $625k
- Monthly Cash Expenses: $1,500k
By subtracting the two, we get -$875k as the net loss per month.
- Net Loss = ($875k)
Recall the gross rate variation takes into account solely the cash losses.
As a result, the “Monthly Gross Burn” can just be linked to the “Total Monthly Cash Expenses”, ignoring the $625k made in sales each month.
For this start-up, the gross burn amounts to a loss of $1.5mm each month.
- Gross Burn = ($1.5 million)
3. Net Burn Rate Calculation Example
If the monthly cash sales were also considered, we would calculate the “net” variation.
Here, the monthly net burn is a straightforward link to the net cash inflow / (outflow) cell.
Upon adding the cash sales to the total cash expenses, we get $875k as the monthly net burn.
- Monthly Net Burn = $625k – $1,500k = ($875k)
4. Implied Cash Runway Analysis
Based on the two data points gathered – the net losses of $1.5mm and $875k – we can estimate the implied cash runway.
Starting with the cash runway for the gross burn, the calculation is the total cash balance divided by the monthly gross burn.
The implied cash runway comes out to 7 months, which means that assuming no cash sales going forward, the start-up could continue to operate for 7 months before needing to raise financing.
To calculate the cash runway, the only difference is that the total cash balance is divided by the monthly net burn.
The completed output sheet below shows the implied cash runway under the net burn is 12 months, so taking the cash inflows into account, that implies that the start-up will run out of funds in 12 months.
Generally speaking, a start-up of this size with $7.5mm in run-rate revenue (i.e., $625k × 12 months) is likely near the midpoint between an early-stage and growth-stage classification.