How to calculate burn rate (the right way!)
Burn rate is a measurement of how fast your business is spending (or burning through) cash. It’s an important metric for all companies, but particularly for startups which are more likely to be operating at a loss in their first years of growth.
Burn rate is used to calculate cash runway—that’s the amount of time your business has left before it runs out of money.
Venture-backed businesses use burn rate to determine when they need to plan their next funding round. In turn, investors use burn rate to measure the financial health of a business, and gauge whether it’s a good idea to put in money.
Ultimately, managing burn rate is a balancing act between profitability and growth.
A fast burn rate could be a red flag if your business doesn’t have a solid plan for reaching profitability in the future. A slow burn rate could indicate that your business isn’t making the most of its available capital, and is likely to be overtaken by more aggressive competitors.
In this article, we’ll explain how to calculate gross and net burn rate the right way. We’ll also show you how to work out your cash runway, and I’ll take a look at how successful startup founders manage burn rate in the early years of their business.
How to calculate burn rate
The best way to calculate burn rate is over a quarterly, six-month or annual period. Measuring burn rate over shorter periods can throw back misleading data if your spending and revenue varies from month to month.
For example, if your business spends $500,000 in January, $100,000 in February and $700,000 in March, you’ll want to look at spending across all three months to get an accurate view of your burn rate for the year so far.
You can find all the information you need to measure burn rate on your cash flow statements. But before you get your calculator out, you need to decide whether you’re measuring gross or net burn rate.
Gross Burn Rate vs Net Burn Rate
The difference between gross and net burn is simple. Gross burn tells you the amount your company is spending on operating costs such as staff salaries, rent and equipment, per month. It does not take revenue into account.
Net burn shows you how much money your company is losing per month. It takes your company’s spending and revenue into account. So, if your company is spending a lot but also generating sales, the revenue you’ve made will mitigate your net burn rate.
Net burn rate is the metric you should use when calculating your cash runway.
Gross burn rate formula
To measure your average monthly gross burn rate over a set period of time, the formula is:
Expenses / Number of Months = Gross Burn Rate
For example, Awesome Tech Ltd decide to calculate their average gross burn rate over Q1. The company's operational expenses from January - March total $573,000. They apply the following formula:
573,000 / 3 = 191,000
Their average gross burn rate for the quarter is $191,000 per month.
Net burn rate formula
To calculate net burn rate over a set period, take your cash balance at the beginning of the period and subtract the cash balance at the end of the period, then divide by the number of months in that period. The formula looks like this:
(Starting Balance - Ending Balance) / Number of Months = Burn Rate
For example, Cool Horses Inc decide to calculate their net burn rate for the first 6 months of the year.
They look at their financial statement and see that at the start of Q1 their cash balance was $1m. At the end of Q2, their cash balance stands at $400,000. They apply the following formula:
(1,000,000 - 400,000) / 6 = 100,000
Cool Horses Inc’s net burn rate is $100,000 a month.
How to calculate cash runway
Startups often take a few years to become profitable, so having a high net burn shouldn’t necessarily concern you. What should concern you is your cash runway.
Your cash runway tells you how many months you have left before your company runs out of money. Once you’ve calculated your net burn, working out your cash runway is easy.
Take your cash balance and divide it by your net burn rate. The result is the number of months you have in your cash runway.
The formula is:
Cash Balance / Net Burn Rate = Cash Runway
For example, Love Dating App has a current balance of £200,000. Their net burn rate is £50,000 a month. They apply this formula to work out their cash runway:
200,000 / 50,000 = 4
If Love Dating App doesn't generate more revenue, secure investment, or cut back on spending, they’ll run out of cash in four months!
✅Top tip: a smart way to reduce burn rate without impacting productivity is to put the right financial infrastructure in place. Sign up for a free Airwallex account and spend less on fees and more on growth, with free international transfers, bank-beating FX rates, and 0% domestic or international card fees.
What is a “good” burn rate for startups?
Where you are in your growth journey will affect your decision making when it comes to establishing a target burn rate.
An established business may want to limit spend and retain profit in order to pay out dividends to shareholders. Whilst a startup is likely to invest profits back into the business in order to stimulate growth.
Burn rate is a metric that venture capitalists keep a close eye on. But that doesn’t mean your aim should be to spend as little as possible. In fact, investors want to know that you’re spending on growth in order to generate future profits.
If your business has plenty of cash in the bank that you’re afraid to use, investors may question your judgement and long term ambitions.
Alexej Pikovsky is a former investment banker and the CEO and Co-Founder Alphagreen Group, an Amazon aggregator founded in 2019.
"Our investors were more interested in growth than profits,” says Pikovsky. “We never drove growth at all costs, but tried to grow sustainably at all times. We were initially focused on building the infrastructure and the product aggressively, while we are now focused on pushing the product and the services out to generate more sales.”
Ben Brading is a chartered accountant and the founder of AquaSwitch. "Angel investors and Venture Capital funds are very comfortable with the idea of a big cash burn," says Brading. "When raising funds, you'll present a business plan where you'll forecast your cash burn month by month. As long as there are no nasty surprises for investors, the cash burn will be no problem. Investors are more concerned with hitting big milestones and revenue growth."
That said, the fact that 38% of startups fail because they run out of cash is a sobering thought. No investor wants to plough money into a business that doesn't have a clear path to profitability.
Anna Morrish is the Founder and Owner of award-winning digital marketing business Quibble. As an experienced marketer, she often notices other agencies and startups promoting how quickly they’re growing.
“They shout about hiring, hiring again and then hiring some more,” says Morrish. “Then the rumours begin…they’re actually struggling to stay afloat. It's fine to fake it ‘til you make it, but only to an extent. Focus on ensuring there’s money in the bank and profits to reinvest and grow sustainably. 90% of businesses fail in the first year, and it’s often because they try to run before they can walk.”
The key takeaway here is that startups should invest in growth whilst keeping a razor sharp focus on long term profitability, and enough cash in the bank to deal with the unexpected.
How long should your cash runway be?
Operating close to the financial brink is no way to run a business.
Companies backed by venture capitalists should give themselves plenty of time to execute their next funding round, bearing in mind investors are unlikely to risk capital on a business that’s a hair’s breadth from going bust.
Established businesses and startups alike should give themselves enough buffer to deal with unforeseen circumstances (of which we’ve seen a few in recent years!) without facing a full on crisis.
"Eighteen months is a good runway,” says Pikovsky, “as it allows a six-month time buffer for a company to raise its next round while having twelve months to focus on execution and growth of the business. Equally, if the company decides not to raise money, six months is a good time to put structures in place, reorganise the business and raise debt instead of equity."
How to improve burn rate
If you want to reduce your net burn rate, you have two options: make more money or spend less of it. You know best how to generate money for your business, so let’s focus on the latter option.
The key is to reduce spending without impacting productivity. To achieve this, you need to improve efficiency.
A good place to start is your logistical and financial infrastructure.
1) Reduce your COGS (cost of goods sold)
Reducing COGS (cost of goods sold) doesn’t have to mean compromising on product quality.
If you import products, make sure your suppliers are cutting you a good deal. As you scale and require more stock, there should be an opportunity to negotiate a better cost per unit. If your suppliers don’t play ball, see if one of their competitors can offer a better price.
Other ways to reduce COGS include using an economical freight company, ensuring you don’t over-order inventory, and shifting any excess stock during sale periods to avoid overpaying on warehouse costs.
2) Modernise your financial infrastructure
Many startups throw away money on excess fees because they don’t have the right financial infrastructure in place. High street banks charge extortionate rates for account management, foreign exchange and international payments, and many businesses don’t realise that there is an alternative.
Airwallex offers free international transfers, market-leading FX rates, and 0% international card fees. You can open multiple foreign and international current accounts in a click and we don’t charge you any account or set up fees. So you can spend less on bank fees and more on your business’ growth. 3) Get paid on time
Late payments are the bane of many founder’s lives. According to a study by the FSB (Federation of Small Businesses), one in three businesses has experienced late payments in 2022 so far. And one in ten say late payments are threatening the viability of their business.
To avoid late payments, ensure you invoice on time and continue to remind customers when their payments are overdue. If you sell high-value products or services, it’s a good idea to check your customer’s credit score before you deliver to ensure they can afford to pay their bills.
You can also ask customers for upfront or part payment before you complete a job or delivery in order to protect yourself against non-payment and ensure you have plenty of cash to cover your overheads.
4) Choose the right tech stack
Choosing the right tech stack is a great way to save your business money and improve productivity. If you’re concerned that a tech solution is costing too much, research the alternatives. There could well be a better value option that delivers the same service.
For example, using the Airwallex payment gateway rather than competitors like PayPal and Stripe will make it cheaper to accept online payments from domestic and international customers.
Remember, investing in quality tech, such as the right accounting software or payments partner can save you money later down the line.
Spend less on fees and more on growth with Airwallex
The key thing to remember when it comes to managing burn rate is that you should aim to spend efficiently without compromising on growth and future profitability.
Airwallex is designed to help you do just that.
Open a free account today and you’ll have the tools you need to push into new markets and increase revenue whilst reducing your overheads. Our customers have reached new markets and added as much as 3% back into their bottom line by switching to Airwallex.
The benefits of an Airwallex business account include free international and domestic money transfers, bank-beating FX rates, 0% domestic or international card fees, and cheaper online payment acceptance.
To learn more, sign up free today.
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