Understanding financial metrics has become paramount in the landscape of enterprise and business management.
One such critical metric is the cash burn rate, which acts as a compass for evaluating a company’s financial health.
Calculating the burn rate is particularly critical when your organization is in its starting phase because only 80% of startups survive in their early days.
Monitor your cash burn rate on a regular basis to identify trends and stay up-to-date. If your burn rate is frequently high, you can consider reducing your costs or seeking extra funds to increase your financial stability.
In this article, we will discuss how it is calculated and what is the burn rate formula.
What Is Cash Burn Rate?
The cash burn rate, often referred to as the burn rate, encapsulates the rate at which a company spends its available cash balance over a specific period, usually monthly.
This metric is pivotal for startups and the established industry, as it provides insight into their sustainability and runway—the duration until they exhaust their cash reserves.
How To Calculate Cash Burn Rate?
Calculating the cash burn rate is straightforward yet insightful. There are two types of burn rates: the gross burn rate and the net burn rate. Let us understand the formula for determining burn rate;
1. Gross Burn Rate
The gross burn rate is based on a company’s monthly operating expenses. It is calculated by summing up all monthly running expenses, including salary, rent, and overhead costs. The company’s burn rate indicates its cost efficiency, regardless of its revenue.
The formula for burn rate is
For instance, consider an e-commerce company spending $3,00,000 in three months. For this, the cash burn rate formula would be:
$3,00,000/3 months = $1,00,000 average gross burn rate
2. Net Burn Rate
The Net Burn Rate is the rate at which an organization is losing money. It is computed by deducting its operating expenses from its revenue. It is based on monthly cash burn practice, which shows how much cash flow a company requires to run for some time.
However, revenue fluctuation is one element that needs to be controlled. A decline in revenue with no change in expenses can lead to a higher burn rate.
Let us understand the previous example: a company had $3,00,000 in expenses for three months. Let’s say the company earned $2,40,000 in revenue during that period. For this, the burn rate calculation would be;
($2,40,000- $3,00,000) / 3 months =$20,000 per month average net burn rate
In simple terms, the company is spending $20,000 per month above what it earns in revenue.
Tips to Reduce the Cash Burn Rate
While having a high burn rate isn’t an inherently bad thing, prudent management frequently seeks to maximize it. Following are some strategies to reduce the burn rate:
1. Streamline and Reduce Expenses
The Burn rate is directly related to expenses; hence, it is imperative to scrutinize spending to see where you can streamline or reduce it. Certain costs, such as raw materials, are always controllable.
But are there any unnecessary expenses that you can lower without negatively impacting your business? Yes, this includes underutilizing office areas, expert advice that isn’t adding any value, and internal software that the company no longer uses.
2. Focus on Revenue Generation
Emphasize revenue-generating activities to improve cash flow while decreasing expenditures. Consider where you can raise prices, increase average order values, or look into goods that could be improved to increase income.
By focusing on revenue-generating activities, businesses can tailor their marketing and sales efforts to attract and retain high-value customers.
3. Negotiate Payment Terms
To relieve immediate cash runaway, work with vendors and suppliers to negotiate acceptable payment terms.
Open a discussion with your suppliers about obtaining better rates. For example, you could try for discounts on bulk purchases or fight with an alternative supplier with lower prices.
4. Optimize Resource Utilization
To reduce waste, ensure that resources, such as human capital and infrastructure, are used to their full potential. Any bottlenecks or inefficiencies in your processes can cost you both time and money.
Search for ways to improve your supply chain, automate operations whenever possible, and minimize layoffs.
You May Also Read: How To Prepare a Cash Flow Statement: Complete Guide
5. Seek Funding Alternatives
Consider a variety of funding possibilities, such as grants, loans, or equity financing, to supplement financial reserves sustainably. An outsider can sometimes provide a more objective perspective on your company.
You might be able to get recommendations from people you already work with, such as business mentors and investors. A compensated financial adviser can also help you plan and organize your firm.
Conclusion
The burn rate is based on business expenses that can vary from time to time. However, it is a reliable indicator. There are many free burn rate calculators available on the market that will do the job just fine.
Many business management software companies deploy such a calculator to prevent businesses from running out of cash. Calculating the burn rate of your startup business and ensuring that you have at least six months’ worth of cash might help your company survive and eventually become a success.
Amaey Anand is a certified accountant with over 10 years of experience in the finance industry. He has worked with various organizations to streamline their petty cash management processes and reduce inefficiencies. He has also written several articles on financial management for leading publications such as Zensuggest and The Wall Street Journal.
