What is a cash burn rate in business?
How do you calculate yours? What is its importance in your organization? How can you shrink yours if it is killing your company?
What Is Your Cash Burn Rate?
Cash burn rate is effectively the amount of money your company is losing. It is your negative cash flow.
Burn rate is typically quoted on a monthly basis. So, if you have a cash burn of $2M, that means you are losing $2M per month.
This is a very common term in the world of startups and venture capital. Young companies have had a habit of burning through a lot of money through the first few years in business. Though even very large companies have been notorious for losing money every quarter, even though they’ve been valued at billions and have gone public.
Calculating your burn rate is the same as figuring out your monthly negative cash flow. So, if you have no revenues and your expenses are $10,000 per month, your cash burn rate is $10,000 per month.
Any revenues you do have offset this figure. Though you may also have additional costs of goods sold when you are making sales. So, if your static expenses and overhead are $10,000, your costs of goods sold is $10,000, you now have $20,000 in expenses. If you have revenues of $30,000, then your burn rate is still $10,000.
Burn Rate & Fundraising
The most common use of this term is in startup fundraising. You need to know your burn. It will be one of the top questions prospective investors ask when pitching.
The primary reason for this is that your fundraising round should be giving you enough runway to get through to your next milestone and the point where you are eligible to raise another round of funding.
For example, if your burn rate is $100,000 a month, you will likely be raising enough to get you through at least 12 months. Maybe 18 months with enough cushion to absorb delays in closing the next round. You’ll be looking to raise at least $1.2M. That’s not counting any planned increase in expenses.
Your runway is the number of months of cash you have left at this burn rate. You also must make sure you are raising enough money to hit the next fundable milestone. That may be nailing product-market fit, or getting to revenues.
Remember that storytelling plays a key role in fundraising and you will need capital to scale things up. This is being able to capture the essence of the business in 15 to 20 slides. For a winning deck, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
The Dangers Of A High Burn Rate
While burning lots of money has been trendy, it is also highly risky. At least in most cases.
A high cash burn rate means you are losing money every month. It’s really only a matter of time before you are bankrupt when you continue to operate in this position. At least, unless you are lucky enough to raise more money, get to profitability, or sell the company.
There are no guarantees of any of these things. Even in spite of the best planning.
Why Companies Run High Burn Rates
We’ve seen many big and notable companies running extreme burn rates. Uber and WeWork were big examples of this in the world of startups.
Zillow is an example of a high profile public company that has been around for years, and is still losing money. Despite being in business for 14 years and owning one of the most visited sites on the internet, they are notorious for burning tens of millions of dollars per month.
They recently went further with a big pivot into buying and selling homes themselves, like Opendoor which raised at least $300M itself. Both were making big bets losing lots of money on a space they hoped could be worth $20B a year. Then the coronavirus hit, and they stopped this lane of their business.
They thought they could buy the business and industry by expanding rapidly. In the case of Uber it was subsidizing rides. With WeWork it was incredible leverage. Then when interruptions come, like natural disasters, regulator push back or future funding is cut off, it doesn’t matter how big you are, you may only be months from bankruptcy. Even JC Penney and Neiman Marcus, with are 100 plus-year-old companies found that they ended up in bankruptcy with just a couple of weeks of their income being turned off.
Many startup companies have to temporarily run a burn rate until they can get sales and income in the door. Others make it their business plan. They count on getting to big scale to make their idea work. Like marketplace business. Or they plan to just keep raising and gaining market share at any cost until they can sell the company off or take it public.
What’s An Acceptable Burn Rate?
For some it may just be a few thousand dollars per month. For others it has been millions, and even billions a year. Often without any concern.
There are really four factors that play into this decision:
- The market and potential reward for the risk being taken
- The direction of the general economy and industry
- The future availability of capital to keep up this strategy
- Having a fast path back to profitability and solvency if the above works against you
How To Lower Your Cash Burn Rate
If you want to limit this risk, or have run into trouble with a big burn rate, there are two main choices.
- Increase your income to offset your burn
- Cutting business costs to reduce losses
Some of the obvious ways to reduce burn by cutting costs today are:
- Staff layoffs
- Shedding unnecessary office space, equipment, and recurring bills
- Running on in-demand, just-in-time inventory
- Moving to a digital or software product or service instead of hardware
You are going to need to include the burn rate estimates in your business plan or 18 to 24-month roadmap. I cover in detail in the video below how to write a business plan which you may find interesting.