There is a fair amount of jargon in the financial world, and some terms mask concepts that are difficult to decipher. Burn rate is not one of those terms. In this article, we’ll explain what burn rate is, how to calculate it, and why it can be a life-or-death metric for your start-up.
What is Burn Rate?
Burn rate describes what happens when capital is invested into a business, and a timeline is created to either use that money to fund the project and get it to market or to find more funding. Essentially, burn rate tells you how long you have until your money runs out.
It’s usually expressed in dollars per month, but business owners can use whatever time frame makes sense to them, drilling down into dollars per week or even dollars per day for those who are looking for more granular data.
Looking at the burn rate forensically will answer the question: “If things continue as they have been, how long will the business survive?” but won’t necessarily capture the whole picture going forward. To get the most accurate burn rate, it’s best to look at future income, expenses, and budgets. With this information, you’ll be able to see the effect on your capital over time.
Who looks at Burn Rate?
Stakeholders like owners, partners, banks or other lenders should look at burn rate. These parties will want to know how long it will take for projects to come to fruition and how long before they’ll start to see a return. Banks need to know that borrowers will be able to satisfy repayment terms, and investors want to know when they’ll see a return on their investment. As a business owner or partner, you’ll want to know that you can continue operations without running out of money.
Keeping these parties satisfied will be much easier with a solid handle on finances and the ability to report regularly with numbers that make sense for the industry and the way the business operates. If a business is burning through its seed capital too quickly, its investors may want to look a little closer at how they operate.
Why is Burn Rate especially important for a start-up?
Burn rate is important for start-ups because it helps to forecast how long their limited money will last, allowing them to stay on top of it and manage their finances tightly.
Start-ups often operate off of seed funding and don’t have the regular income provided by sales. If projects run over time or budget, these businesses can get themselves into trouble with negative bank balances, overdraft fees, or even lenders calling on them.
Crescendo Accounting & Consulting Business Manager Ryan Vu, CPA, says: “If you find yourself scrambling, it can be really challenging to find new funding or find a new investor – you may end up with a bad lending rate or no money at all, which is a dangerous position for a new business to be in.”
Is Burn Rate just seed capital, or does it include sales and operations?
Burn rate can include both seed capital or investments AND operational income. Established companies that have more predictable regular income streams will benefit from monitoring burn rates to manage cash flow. However, start-ups tend to rely on seed money and early adopters to finance their operations. For this reason, it’s incredibly important for start-ups to pay attention to burn rate since their income can be feast or famine, and that money can get used up quickly by R&D and other activities to get them out into the marketplace.
How do you keep Burn Rate under control?
You keep burn rate under control by looking at it frequently and budgeting ahead.
This means paying attention to what the business’s real expenses are and not assuming that everything is fine because there is money in the bank. Salaries, monthly subscriptions, and one-time or annual payments can dramatically affect cash flow. Especially for tech companies, even if there is a profit on paper, they’re not immune to trouble. It’s important to forecast the periods where there won’t be as much money coming in or where larger, known expenses will occur in order to steward their finances wisely.
A budget gives a business a general burn rate, but that actual number will vary from month to month, so it’s important to not only use this forecasting tool but to stay on top of it as the business’s financial position changes. If a business cuts some costs, gains a new client or receives new funding, it may slow down its burn rate (more money = more runway), but if they lose a client or if they have a large expense, it may speed up its burn rate. Ryan recommends monitoring and continually adjusting the burn rate over a period of 6-9 months.
Now that I know my burn rate, what do I do?
“The best companion to a burn rate is a plan to manage your finances.”
Remember: The best companion to a burn rate is a plan to manage your finances. These tools create a roadmap for your company, so you know where you’re going and help you put the right pieces in place to achieve your goals and dreams.
Crescendo Accounting & Consulting helps business owners create and maintain momentum toward their success. We are currently accepting new clients. reception@crescendo-cpa.ca
