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Burn Rate

Understand the Burn Rate Concept

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Burn Rate

In This Article
  • How do you calculate the gross and net burn rate?
  • Why does the burn rate matter for companies, especially start-ups?
  • What is the term “cash runway” in reference to?
  • Is a rapid burn rate always a cause for concern?

Burn Rate Definition

Using the burn rate, the implied cash runway can be estimated – in other words, the number of months that a business can continue operating until it runs out of cash.

To sustain operations, the start-up must either become profitable or, more commonly, raise equity financing from outside investors before the cash on hand runs out.

Often associated with venture investing, the burn rate indicates how long a start-up has until its operations can no longer be sustained and more funding becomes necessary.

By tracking the metric, a management team can quantify the number of months they have left to either turn cash flow positive or raise additional equity or debt financing.

In particular, the metric is closely tracked by early-stage start-ups that, in all likelihood, are operating at steep losses.

Since it could take up several years for the start-up to turn a profit, the burn rate provides insights as to how much funding a start-up will need, as well as when it will need that funding.

Importance of Metric in Venture Capital (VC)

The reason why these concepts hold such high importance to venture investors is that nearly all early-stage companies fail once they spend all their funding (and existing and new investors are not willing to contribute more).

Furthermore, no investment firm wants to be the one attempting to “catch a falling knife” by investing in a high-risk start-up that will burn through the cash proceeds from the investment only to call it quits soon after.

By understanding the spending needs and liquidity position of the start-up, the financing requirements can be better grasped, which leads to better decision-making from the perspective of the investor(s).

An important distinction is how the metric should account for only actual cash inflows/outflows and exclude any non-cash add-backs, i.e. a measurement of “real” cash flow.

The resulting runway estimation is thereby more accurate in terms of the true liquidity needs of the start-up.

Putting this all together, by tracking the monthly cash burn, the start-up benefits by gaining insights on:

  • Spending needs to plan ahead of time for its next round of funding
  • The costs associated with financing operations (and the revenue level that must be brought in to begin generating a profit – i.e., the break-even point)
  • The number of months the current level of spending can be maintained before needing more funding
  • Or for seed-stage companies, how long the company has to work on product development and experiments
  • Being able to compare the spending efficiency and see how it translates to output

Burn Rate Formula

Broadly, there are two types of the metric:

  1. Gross Burn
  2. Net Burn

The calculation of the gross burn only takes into account the total cash outflows for the period into consideration.

Gross Burn = Total Monthly Cash Expenses

In comparison, the net burn takes into account the cash sales generated – therefore, the outflows are net against the cash inflows from operations in the same time period.

Net Burn = Total Monthly Cash Sales – Total Monthly Cash Expenses

The gross burn is the total amount of cash spent each month, whereas the net burn is the difference between the monthly cash inflows and cash outflows.

Implied Runway Formula

The calculated rates from above can be inserted into the following formula to estimate the implied cash runway.

Implied Runway = Cash Balance / Burn Rate

From the equation above, the implied runway can be calculated, which again is the number of months a company has left until the cash balance drops to zero.

Example Start-Up Calculation

For this simple calculation, use the following assumptions.

  • A start-up currently has $100,000 in its bank account
  • The total cash expenses each month are $10,000
  • At the end of each month, the net change in cash for the month is $10,000
  • By dividing the $100,000 in cash by the $10,000 burn, the implied runway is 10 months

Within 10 months, the start-up must raise additional funding or become profitable, as the assumption here is that the monthly performance remains constant.

Note, there were no cash inflows in the example above – meaning, this is a pre-revenue start-up with a net burn that is equivalent to the gross burn.

If we assume that the start-up has monthly free cash flows (FCFs) of $5,000, then:

  • The $5,000 in cash sales is added to the $10,000 in total cash expenses
  • The net change in cash per month is cut in half to $5,000
  • Upon dividing the $100,000 in cash by the $5,000 net burn, the implied runway is 20 months

In the 2nd scenario, the company has twice the number of months in cash runway because of the $5,000 in cash inflows coming in each month.

Burn Rate Calculator – Excel Template

Now, we’ll move on to a modeling exercise. To follow along, download the template using the form below.

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Total Cash Balance Calculation

First, we will calculate the “Total Cash Balance” line item, which is simply the existing cash-on-hand plus the funding raised.

In this scenario, we are assuming that this start-up had $500k in its bank account and just raised $10mm in equity financing – for a total cash balance of $10.5mm.

Total Cash Balance

Note that we are assuming that this is the cash balance as of the beginning of the period.

Gross Burn Calculation

Next, the remaining operating assumptions are that the start-up has the following cash flow profile:

  • Monthly Cash Sales: $625k
  • Monthly Cash Expenses: $1,500k

By subtracting the two, we get -$875k as the net loss per month.

Net Cash Inflow-Outflow

Recall that the gross rate variation takes into account solely the cash losses.

As a result, the “Monthly Gross Burn” can just be linked to the “Total Monthly Cash Expenses”, ignoring the $625k made in sales each month.

Gross Burn Rate

For this start-up, the gross burn amounts to a loss of $1.5mm each month.

If the monthly cash sales were taken into account as well, we would be calculating the “net” variation.

Net Burn Calculation

Here, the monthly net burn is a straightforward link to the net cash inflow / (outflow) cell, as shown below:

Net Burn Rate

Upon adding the cash sales to the total cash expenses, we get $875k as the monthly net burn.

Implied Runway Calculation

Based on the two data points gathered (-$1.5mm and -$875k), we can estimate the implied cash runway for each.

Starting with the cash runway for the gross burn, the calculation is the total cash balance divided by the monthly gross burn.

Gross Implied Runway Formula

The implied cash runway comes out to 7 months. This means that assuming no cash sales going forward, the start-up could continue to operate for 7 months before needing to raise financing.

To calculate the cash runway, the only difference is that the total cash balance is divided by the monthly net burn.

Net Implied Runway Formula

Burn Rate Calculator Output Sheet

From the completed output sheet posted below, we can see the implied cash runway under the net burn is 12 months.

Burn Rate Output

Taking the cash inflows into account, this implies that the start-up will run out of funds in 12 months.

Generally speaking, a start-up of this size with $7.5mm in run-rate revenue (i.e., $625k × 12 months) is likely near the midpoint between an early-stage and growth-stage classification.

Average Rate of Early-Stage Startups (VC)

A typical start-up will typically begin the process of raising additional funding from new or existing investors when the remaining cash runway has fallen to approximately 5 to 8 months.

Given the amount of funding raised in the previous round, the $10mm, running out of cash in one year is considered fast.

On average, the time in between raising a Series B and Series C round ranges between ~15 to 18 months.

However, note that this entirely depends on the context of the start-up (e.g., industry / competitive landscape, prevailing funding environment) and is by no means intended to be a strict timeline that all start-ups follow.

For instance, a start-up that does not expect to run out of cash for more than two years with significant investor interest could raise its next round of financing six months from the present day despite not actually requiring the cash.

If a start-up is burning cash at a concerning rate, there should be positive signals supporting the continuation of the spending. For example, exponential user growth and/or promising product features in the pipeline soon to be introduced could potentially lead to better monetization of the customer base – which will be reflected in the LTV/CAC ratio.

A rapid pace of burn is not necessarily a negative sign, since the start-up might be operating in a very competitive industry. Investors are willing to continue providing funding if the product concept and market are deemed lucrative opportunities and the potential return/risk trade-off is considered to be worth taking a chance on.

While an unsustainable rate over the long run can become a cause for concern to management and investors, it ultimately depends on the given company’s specific surrounding circumstances.

By itself, the burn rate metric is neither a negative nor a positive indication of the future sustainability of a startup’s business operations.

Thus, it is important to not view the rate as a standalone metric when evaluating start-ups, since the contextual details can provide more insights into the reasoning for the high spending rate (and if additional funding rounds are on the horizon).

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