Imagine you’re running a technology startup — let’s call it Neo — that promises to change the world with an apparently ground-breaking new invention that solves a huge unmet customer need. You wow a throng of influential investors with your elevator pitch and manage to bag a sizable seed at a high valuation. Sounds pretty good, right?
Then, you hire a team of developers to build out your product — and a sales force to sell it to businesses — and take out a lease on a fancy new office to house your expanding operations. But those overheads of payroll, development, and facilities swell your cost base ten-fold and start to drain your funding at a rapid pace. As the year progresses, you're quickly running out of money.
This nerve-racking situation can be summed up with one major metric: burn rate. Burn rate is the amount of money you’re losing every month as an unprofitable startup, and is indicative of the amount of time you have to get to profitability or to secure further funding from investors.
In this article, we’ll cover what burn rate is, why you should care about it, and how to manage burn rate.
In a nutshell: burn rate is the amount of money you're losing every month if your company is unprofitable. Many startups and their investors use this as a metric of performance, company health, and ultimately, valuation.
Smaller companies often cannot generate positive cash flow in their earlier stages; they focus on growth and expect the cash to pour in later. Certain business models, like SaaS, can require a particularly heavy up-front investment: you may need to hire a team of engineers and designers to build out a product, and start investing in sales and marketing to secure your first customers, all before you see your first dollar roll in.
By getting customers hooked on your product, you can expect to recoup those costs over time, but that can take many months — or even years. Until then, start-ups often rely on investors to provide funding to fuel their operations, and keep a close eye on burn rate as a result.
Burn rate is typically expressed as a monthly sum, though it can also be looked at annually.
If a company has a monthly burn rate of $10,000, it means the business is losing $10,000 every month.
Burn rate is calculated by subtracting cash entering your bank account from cash that’s flowing out of it.
Cash leaving your bank account - cash entering your bank account = monthly burn rate
For example, if the company was spending $20,000 each month but had $10,000 enter their account as revenue, their burn rate would be $10,000.
Another way of thinking about burn rate is the difference between your cash balance at the start of the month and the end of the month.
Cash at start of month - cash at end of month = monthly burn rate
The difference in cash is the amount you’re “burning” every month — hence, your monthly burn rate.
To make it easy, we've also created a cash burn template that you can use to keep track of your burn rate.
It may seem simple, but burn rate is important because it helps predict a company’s cash runway, or how long it has before its capital is exhausted and it needs to lower costs, raise more funding, or simply go under.
So, if a company has $500K in the bank and loses $50K a month, its cash runway would be 10 months, unless it increased revenues, cut costs, or raised additional funding.
Total cash in bank ÷ monthly burn rate = cash runway (in months)
Experts will generally recommend that companies have 18 - 24 months of runway in the bank as a cash buffer. However, in tighter economic times, that recommendation goes up to 36 months or more of runway.
There are a few reasons why you should care about burn rate:
It’s an indicator of how much time you have left before you run out of money. When viewed alongside runway, burn rate depicts how many months a start-up has left before needing to become profitable, raise more funding, or slow its burn rate.
It provides you with “wiggle room” to figure things out. By maintaining a low burn rate, you buy yourself more time to nail down certain aspects of your business, like your product or go-to-market strategy. You’re still losing money every month, but you’re spending it more conservatively. If an unexpected expense occurs or things go sideways, you have more cash in the bank to deal with the consequences.
It can show you whether you’re underinvesting. A high burn rate is not necessarily a bad thing. Investors are giving you money so that you spend it in the right ways. If you’re not spending the capital you've raised and it’s just sitting in your corporate bank account, you could be falling behind your competitors who will invest in marketing, product development and sales to gain more market share. The key thing is to manage your burn rate and spend strategically on growth.
It impacts your ability to raise capital. A high burn rate (and low cash runway) can make it harder to fundraise. If an investor sees that you are running out of money, it becomes riskier to invest in you — if you do secure funding, it'll likely be on worse terms. In good economic times, investors have generally been willing to finance the activities of loss-making startups in high-growth sectors. However in a downturn, investors are less willing to cover cash burn and will expect companies to demonstrate profitability sooner.
A good burn rate is dependent on how much money you have in the bank today. In more challenging economic times, experts typically say that you should have at least 36 months cash on hand to cover your monthly expenditure. Say you had $5 million in cash, and you're trying to stretch it out for 48 months; you could spend about $105,000 per month to keep your business on a solid financial footing.
Of course, many startups in high-growth sectors operate with much higher monthly burn rates, and investors may expect you to be deploying more of their capital to fuel business growth. However, that may create risks to the company’s financial stability.
Ultimately, management will need to take a balanced approach to cash management depending on the needs and aspirations of their business and its investors. It may be necessary to reduce burn rate at certain periods to staunch the depletion of capital and strengthen cash balances.
Lowering your burn rate can be achieved through several measures that include boosting revenue growth and making cost reductions.
Sell more. The least painful thing to do is generate more revenue, if you can. The best scenario is to generate extra cash from sales and marketing activities. You can experiment with different ways to boost your paid or organic traffic, focus on converting more sales leads into paying customers, and consider raising your pricing to get more cash coming in.
Collect payments sooner. An alternative is getting better or faster at collecting payments, and improving cash collections from customers and commitments you are owed. For any payments that have failed or are past due, continue following up on a regular basis. You can also bill customers earlier, suggest a discounted annual plan that’s paid up-front, and use shorter payment terms (like net 30 instead of net 60).
Cut costs, where you can. Look at your monthly cash outflow, and consider what can be cut. Software subscriptions, office space, travel budgets, and agency costs are all under consideration. Many companies suffer high burn rates because they over-hire in expectation of future growth. If that does not materialize, action should be taken to size the company appropriately. There are no easy choices here. It may be necessary to lower payroll costs or consider lay-offs to improve the company’s financial health.
Delay payments. Consider if any upcoming purchase or investment can be put on hold. This could include a new office space, a new software subscription, or a new agency relationship. If you need to move forward with the investment, try negotiating payment terms to provide more time to pay.
Delay or pause hiring. If you’re currently hiring for additional roles, you can pause your search, and wait a few months to re-evaluate whether these roles are needed. Alternatively, if you have offers accepted, you could push back start dates for new joiners to keep the payroll lower in the short-term.
Secure funding. You can weather a drop in sales if you can access additional funds. You could try to tap your investors for more cash in return for equity, or turn to the credit markets and seek business loans, or sell debt via corporate bonds. You could also seek out state subsidies or grants, where possible.
By understanding your monthly burn rate, you put your company in a better position to weather the storm, and make the right investment choices for your business.
Curious to understand your burn rate? Start with our burn rate template, which helps you understand how much money you’re burning every month. The more you understand your burn rate, the better equipped you are to manage it.
Burn rate is the amount of money you're losing every month if your company is unprofitable.
You can calculate burn rate by looking at the difference between your cash balance at the start of the month and the end of the month. In other words, cash at start of month - cash at end of month = monthly burn rate.