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It’s no secret that you need to spend money to make money. However, managing a burn rate can be notoriously tricky. However, if you ignore your burn rate you could run into a host of problems, including:
- If the burn rate is too high a company can go into bankruptcy
- If the burn rate is too low, a company may not grow
- Investors may reject a company based on its burn rate
As a young startup, you must get a handle on your burn rate as soon as possible to have a healthy cash flow and be more attractive to investors.
The Types of Burn Rate
Understanding burn rate sounds simple. It’s just how fast your business spends cash, right? It’s a little bit more complicated than that. Before you start talking about the burn rate of your startup, you should know exactly what kind of burn rate you are talking about.
Gross Burn Rate refers simply to how much cash a business spends in a given month. If you have $20,000 worth of expenses in a month then that’s your gross burn rate right there.
The Net Burn Rate refers to the actual cash lost every month, with revenues taken into account. If you have $20,000 worth of expenses but you are making $10,000 a month, you have a burn rate of $10,000.
While the Net Burn rate is the “realistic” burn rate, it’s still very important to know your Gross Burn Rate. If you only know your Net Burn rate, you might be unaware of just how much cash you are burning through, and left in a bad situation if your revenue fluctuates.
1. Know Your Cash Runway
You might have heard a reference to a “Cash Runway” before - and probably in very worried tones. A Cash Runway is essentially the time you have to operate at a loss before your cash reserves are used up. If you run out of Cash Runway, your startup crashes before takeoff.
Thankfully, the Cash Runway is easy to measure. You simply need to divide your cash reserves by your Net Burn Rate. So, if your Net Burn Rate was $10,000 per month, and you have cash reserves of $60,000, your Cash Runway is 6 months. If you had cash reserves of $100,000, but a Net Burn Rate of $50,000, you’d have a very short runway of only 2 months.
The Cash Runway is essentially a ticking clock, showing you how long you have to adjust your burn rate. It also puts your burn rate into context - even a seemingly good burn rate is a problem if you have very low cash reserves.
2. Find Your Ideal Burn Rate
You’ll note that this section mentioned “Your” Ideal Burn Rate, not “The” Ideal Burn Rate. An ideal company burn rate percentage very much depends on the startup in question. There are a few things you should consider when judging if a burn rate is ideal or not.
- A good Cash Runway should be about 6 months as a rule of thumb. This gives you a buffer, while not leaving you with cash that isn’t being used for the benefit of your company.
- Know what credit is available to you. This can help expand your runway if needed, which then lets you support a higher burn rate.
- Communicate with any venture capitalists you are working with. Many VC firms will have preferences for what kind of burn rates they prefer and may have recommendations for you.
- Make sure your burn rate is sustainable. It’s better to raise a burn rate as your startup takes off than cut down a burn rate due to unrealistic expectations.
3. Adjust Cash Flows to Manage Burn Rate
Being able to define a burn rate is one thing, but how do you get that burn under control? There are a few accounting tricks you can use to get your Burn Rate under control.
Manage Operating Cash Flows: Too often, startups get so excited to set up their business that they take some of their operating expenses for granted. However, you may be spending more on your operations than you need. One place to seriously consider is your team. Do you need to hire for all jobs, or can you do the same through contractors? While contracting may seem expensive, many jurisdictions, such as in Europe, have very expensive social security charges.
Manage Investing Cash Flows: If you are a new startup, you need to resist the temptation to make massive investment purchases to start. You can lease the space and equipment you need rather than making purchases that will lock up your assets in an illiquid form.
Financing Cash Flows: Often, startups don’t consider their financing when it comes to the burn rate. However, there are certain financial expenses that you might want to consider - particularly the interest on loans that you have to pay back. This is still cash that you will owe and should be considered when calculating the burn rate.
Want To Learn More About Managing Burn Rate?
For most startups, managing their cash flow is the major challenge they need to overcome - many startup failures can be attributed to never getting a handle on their cash. Knowing how to manage burn rate can be an invaluable skill for any business.
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Our mission is to help you streamline your back office and to provide you with actionable data and reduce your overhead. Let’s connect to give you a customized quote and free consultation. You have nothing to lose but so much to gain.