Burn Rate – What Is It and How to Calculate It?
To put it simply, the burn rate represents a measurement of how quickly your business is spending money. Often, it is expressed in dollars per month. The burn rate is an important parameter for any new business because it shows how much time is left until it must become profitable.
Here, you will find what a burn rate is, how it is calculated and why it is so important, both for your business and for the investors.
Two Kinds of Burn Rates
So first things first – there are two kinds of burn rates:
The first one shows total spending, and the latter measures net cash flow that represents revenue. Commonly, the burn rate is calculated in terms of months. But, that all depends. If your business is having money problems, you may need to calculate it in a shorter time frame. Even daily sometimes. On the other hand, if your business is financially healthy, you can do this quarterly, or yearly.
Gross Burn Rate – Definition and Equation
The gross rate is calculated by adding all operating expenses which are salaries, rent, etc. This is usually calculated monthly. By doing so, you can gain insight into your business’s costs and efficiency. Here’s how you get it:
Gross Burn Rate = Cash/Monthly Operating Expenses
Net Burn Rate – Definition and Equation
As you might have guessed – this rate shows the rate at which business is losing money. It is measured monthly, same as the gross. Basically, it reveals how much money your business needs to continue operating. Equation for it:
Net Burn Rate = Cash/Monthly Operating Losses
How It Works?
Even the most basic analysis of your business’s net burn rate can show you if your business is self-sustaining or not. When you calculate it and get positive net rate, then your company is having more costs than profits. And, that’s not a good thing. If that happens, two options are available. Either cut costs or increase your business’s revenue.
Furthermore, you can use it to calculate how much time you have. If you don’t fix your financial health before funds run out, then you will have to either get a loan or investor. And, in the worst case scenario – close up shop.
But remember that investors look at a company’s burn rate too. Even after you find a person to invest in your company, chances are they will continue to calculate it to track progress.
Ways to Improve Your Burn Rate
One thing to realize here is – if you have a high rate it means less time for your business to become profitable. Decreasing it, you may give your company needed additional time. There are several ways to improve your rate and here they are:
- Increase your revenue without increasing costs
- Lower your costs
- Refinance your debt
- Pick a cash management system and plan for positive cash flow
Doing this important calculation for your business isn’t difficult. However, it can be tough seeing a high rate and short amount of available time to make it profitable. Silver lining here is in the knowing. If you know that disaster is coming, you can take precautions to prevent it.
When you keep up regularly with your burn rate and cash runway, you will be more prepared to fight any battles your business encounters.
If you are still having trouble with this one – we are here for you! Contact Your Part Time Accountant today and let us guide you through this journey.