Burn rate is a simple metric that every entrepreneur must be familiar with because, if calculated correctly, it’s crucial for planning, growth, and the success of any business. It is used to measure sustainability or how long a company can operate until it runs out of money. But what exactly is cash burn rate and how can we calculate it? Keep reading this article and you will find answers to these questions.
What is Cash Burn?
Burn rate is typically used in connection to startups and describes the rate at which a new company spends venture capital before it reaches profitability. Cash burn metric is a measure of negative cash flow and is expressed in cash spent per month. For example, if a company has a cash burn rate of 4,000, it means that it is spending 4,000 per month.
We can focus on two types of burn rate:
For example, if a startup spends $25,000 a month on rent, salaries, and other overhead, its gross burn rate is $25,000. But if the company is also generating revenue of 10,000 per month, its net burn would be $25,000 - $10,000 = $15,000.
Why Cash Burn Rate Is Important for Investors?
Cash burn rate is especially important for new companies which are unable to produce a positive net income and are seeking startup capital. Seed stage investors and venture capitalists often provide funding, taking into account a company’s burn rate. They compare this metric with the growth of revenue to decide if a company is worth investing in. Investors look for new companies with low burn rate because such businesses are more likely to become profitable and will bring them a better ROI. A low burn rate shows a strong cash position which indicates the business’ health. Hence, you should calculate your burn rate precisely and watch it carefully.Cash burn is one of the many metrics investors will look into. Make sure, your calculations are correct and the data is easy to present. Try Lean Case for business model development.
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Cash Burn Rate Calculation
There are different methods of cash burn rate calculation and some of them are more complex than others. Let’s look at a simple burn rate formula which allows you to calculate your burn rate in two easy steps.
First, you have to determine a period of time for your calculations and review the starting cash balance and ending cash balance for that period. For example, if you would like to calculate the cash burn of your company in the 3rd quarter, you will have to pay attention to the cash balance on July 1st and on September 30th.
For example, on July 1st, the cash balance was $35,000 and on September 30th, it was $20,000. This means you burned $15,000 during this period of time: $35,000 - $20,000 = $15,000
Now you have to divide this difference between two balances by the number of months in the period you have selected. In our example, it would be $15,000 / 3 = $5,000 so your company burned $5,000 per month.
To understand if your burn rate is high or low, you should review your revenue during the same period of time. If your revenue is less than $5,000, you are not in a good position and your investors will be required to inject more cash into your business soon enough. To increase your chances of attracting new venture capital funding, you will need to take measures to reduce your burn rate by decreasing your payroll expenses and direct costs and to improve your sales and cash flow. You should address the high burn rate proactively before it becomes a problem if you want to grow a healthy business.As you can see, burn rate is one of the crucial metrics in business planning and one of the important decision criteria for investors. That’s why calculating and managing your burn rate is essential for your business. But there are a lot of other important factors you need to consider when preparing for the next investment raising round. The best way to keep track of all the important criteria and ensure that your presentation is convincing and not missing crucial elements is to use Lean Case. With the help of our system, you can easily develop a comprehensive business model your investors will be grateful for.
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