How to calculate Burn Rate for a Business?

How to calculate Burn Rate for a Business?

Burn rate is a financial term used popularly amongst entrepreneurships which indicates how a business depletes its cash, either in a loss-making scenario or as a start-up entity.  A business typically is not able to generate a positive net income in its birth stages since it is focussed on product/service development and increasing its customer base.  Potential investors or venture capitalists usually use the burn rate in a business to determine their acceptable funding exposure.

Computing burn rate for a business is fairly simple as it is merely derived as the reduction in your cash balance over the previous month thereby reflecting the business’s negative cash flow.  It doesn’t take into account any liabilities or receivables, or monies transferred between bank accounts of the same business.

Through this article we will explain briefly how is burn rate of a business calculated and what does it imply.  We shall also touch base on the concept of business runway and its significance.

Burn rate is usually categorized into two: 1.) Gross Burn rate & 2.) Net Burn rate.

Gross Burn rate is simply the amount of cash that your business spends in one month and it doesn’t take into account the revenue (incoming money) into your business.

Net Burn rate on the contrary considers the incoming monies into your cash account and so it depicts the actual net cash lost in a month.  In simple words, you shall subtract the revenue received from the spending and use the balance amount to compute your net burn rate.  It helps you understand how much more revenue your business needs to break even or how long does it have before it runs out of money should nothing change.  Net Burn rate is the figure you are mostly concerned with and so we shall refer to it as Burn rate.

 

A burn rate is derived in two possible ways:

-       Including investment funding received or

-       Without investment funding

 

Burn rate including Investor Funding:

This is usually found with easy reference to your financials under the cash flow statements.  This is simple to arrive at, without any adjustments to your cash balances:

Burn Rate = Cash balance in prior month less Cash balance in current month

A burn rate derived this way is the net cash the business is spending every month.

Deriving a Negative or Zero Burn rate?

This burn rate calculation as aforesaid will usually be equal to or greater than zero, however in some situations it may come back as negative, which means your business may be earning more money than you spend or if your business received funding in a particular month, the burn rate will reflect negative because you have gained money for your business overall.  In case of a zero-burn rate, it shows your business is at break even.  This analysis of burn rate is of not much purpose once the business is earning more than it spends, but it’s a useful parameter for start-ups.

 

Burn rate excluding Investor Funding:

Now it is also imperative for business owners or start up founders to know their business burn rate irrespective of their ongoing funding.  In which case the same is derived as follows:

Burn Rate = (Cash balance in prior month less funding received) LESS (Cash balance in current month less funding received)

A burn rate so derived is helpful to assess how to what extent you are able to redeem your business spending from its revenue generating activities.  Also, it gives an indication on the longevity of your business in the event its funding options exhaust.

 

Average Burn Rate

When you calculate the burn rate month over month for your business, for a desired span of time, usually a year or a quarter or six months, you can arrive at the average burn rate for that period by dividing the total of all month on month burn rates by the number of months.

 

Business Runway

Burn rates derived can be used to compute a business runway.  A runway is the number of months your business has left before it runs out of Cash. Here’s how it is calculated:

Runway = Total Cash balance ⁄ Average Burn rate = Number of months before Cash is totally exhausted.

While deriving this runway, you typically do not factor in any investments or additional funding and assume your expenses and revenues remain unchanged.

Usually, your business Finance Director, CFO, Controller or Accounting firm can help you out analysing this.  To know how much cash is needed for your business is an ongoing evaluation.  To assure you have a comfortable cash flux, you should be able to determine through the runway calculations, at different stages in your business, as to by when it is must for your business to secure additional funding or generate more revenue.  It also helps you determine whether you need to control and reduce your burn rate to stop the business bleeding from redundant spending.  You would only want to make sure that every burn rate is justified thereby satisfying you that money is spent appropriately only towards expenses that justify your business end goals.

Conclusion

Besides getting an accurate picture of your company’s financial health, knowing your burn rate and runway is an important step in securing funding i.e., whether to invest your own capital or secure external funding. These computations of burn rate and runway are crucial for start ups who are yet to launch their products or services.

 

We trust this article was helpful to you in understanding in brief what burn rate is and its significance for business cash analysis.  Should you have any queries or need consultation, Schedule a Call today or write to us at info@gjmco.in.

 

Thanks & Best regards,

Knowledge Base team

GJM & Co.

Chartered Accountants

www.gjmco.in

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