What is Burn Rate?
The startup metric Burn Rate is the negative cash flow of a company. It shows how quickly the startup is spending money. This key metric is essential for determining how much cash the company needs to keep operating and growing.
Advice from VCs: Why Burn Rate is critical
“[Burn rate] is what signals to existing investors how quickly their teams need to be fundraising and the level of risk the company is facing. It also signals to potential new investors both how quickly you need to raise (i.e. you have less leverage if you’re in a rush) and how much cash you’ll need if they fund you.” - Mark Suster, Managing Partner at Upfront Ventures
“Assuming a constant burn rate can be very dangerous. Always know if your burn rate is going up or down and include that fact in your analysis.” - Fred Wilson, Partner at Union Square Ventures
“If the startup is just at inception and there is literally no product at all, then the only metric I care about is burn rate.” - William McQuillan, Partner at Frontline Ventures
How to calculate Burn Rate:
Gross Burn Rate Calculation:
[ ($) total amount spent month B
($) Total amount spent month A ]
($) Total amount spent month A
(%) Gross Burn Rate
Net Burn Rate Calculation:
($) total amount spent month A
($) total revenue month A
($) Net loss month A
($) total amount spent month B
($) total revenue month B
($) Net loss month B
[ ($) net loss month B
($) net loss month A ]
($) net loss month A
(%) Net Burn Rate
Burn Rate can be calculated as gross or net. Gross burn rate is the total amount of money spent month-over-month. Net burn rate subtracts the total revenue from the total amount of money spent month-over-month.
Gross Burn Rate can be calculated by subtracting the total amount spent in the previous month from the total amount spent this month. Then divide the result by the total amount spent in the previous month and multiply by 100 to convert it to a percentage.
Net Burn Rate is calculated similarly - just replace the total amount spent with the net loss for each month. Net loss can be calculated by subtracting the total revenue from the total amount spent for each month.
Burn Rate is a critical metric in determining how many months worth of cash a company has in the bank. This is sometimes referred to as ‘X months of runway.’
A number of different sources and events can impact your burn rate such as a change in the economy or a product cycle transition. Tracking your Burn Rate helps you monitor the financial health of your company and catch any sudden changes that might hinder continuing operations. It’s also a way of keeping your pulse on your spending and managing your expenses. Costs can add up quickly if you’re not careful and it’s important to operate leanly as a startup.
Your burn rate might be misleading if seemingly ‘one-off’ expenses aren’t included. Calculate all money spent in your Burn Rate (both for gross and net), then you can always dig deeper if you see a sudden spike in burn rate one month.
It’s also important to understand what percentage of your burn rate is from fixed costs (office, equipment, etc.) versus variable costs (one-time marketing campaign, event, freelancers/contractors, etc.) that you can reduce quickly. This way if the market suddenly dips, you can manage your Burn Rate so you don’t run out of cash before either boosting revenue or raising more funds.
Relevant Startup Metrics and KPIs:
If you’re adding Burn Rate to your Startup CEO dashboard, you might want to also consider tracking these related startup metrics for context.
Burn Rates will vary significantly depending on the company stage, pricing model, and industry. There’s no universal right answer, but a good benchmark is to always have at least six months worth of cash in the bank based on your current burn rate.
“Be careful about ever dipping below six months of cash in the bank.” - Mark Suster, Managing Partner at Upfront Ventures
“It’s OK if you want to spend money to be aggressive for growth or speed. The thing that is not OK is if the plans change or environment changes, you should be able to reach profitability on the money you have. What is OK is to spend money for productivity. What is not OK is just to light money on fire.” - Sam Altman, President of Y Combinator (from an interview with Business Insider)