What is burn rate?

October 20, 2021
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Expenses and profits are two of the most vital things small business owners can track. There are at least two ways small business owners can measure funds used to determine business expenses and profitability, which is known as burn rate.

You can use the burn rate to establish your business’s economic standing, whether it’s a startup, growing, or already established. Here’s what you should know about the burn rate for businesses.

What is burn rate?

Burn rate is a measurement of how quickly a business spends its money and how much money it’s spending. Burn rate can be helpful for startup businesses to determine how much time the business has before it becomes self-sufficient. Burn rate can also factor into potential investment opportunities too. 

Investors often look at a business’s burn rate to determine if the business is worth financing or investing. If a company seeks investment opportunities, an investor will compare the burn rate to its business plan. This will help the investor determine if a small business may become profitable in the future.

Burn rate may be helpful even if your business is already profitable. Businesses can use burn rate to establish their runway, or the amount of time a business has before it completely runs out of money. This will also provide information about how long your business can maintain itself financially with its savings instead of profits.

In most cases, you’ll see the burn rate expressed as a number. This number will provide details on how many months your business can sustain itself before becoming profitable. Depending on your small business, there are different times and ways to express burn rate: 

  • Businesses without financial concerns can calculate their burn rate annually.
  • These businesses may also choose to calculate burn rates quarterly.
  • In dire situations, you can express the burn rate in days or weeks for small businesses that aren’t generating profits.

What are the two types of burn rates?

There are two types of burn rate: gross burn rate and net burn rate. Both burn rates can provide vital information on the financial trajectory of your small business.

Gross Burn

Gross burn rate is the amount of operating costs a small business has monthly. It also describes the total cash spent during the month without considering revenue. 

The operating costs include direct costs of goods sold (COGS) and selling, general, and administrative (SG&A) costs. You’ll find the operating costs on your small business income statement.

Small businesses may experience the following COGS costs: 

  • Equipment
  • Funds (for research and development)
  • Insurance
  • Inventory costs 
  • Marketing
  • Payroll
  • Rent

Small businesses may also experience the following SG&A costs:

  • Advertising
  • Commissions
  • Promotional materials
  • Rent, supplies, and utilities not part of manufacturing
  • Salaries

Net Burn

Net burn rate is the total amount of money a business loses monthly. Unlike the gross burn rate, the net burn rate accounts for both cash flow and revenue. The net burn rate will tell you if your business is profitable or not, which is expressed as the difference between expenses and revenue.

If the net burn rate of your small business is positive, it can mean that your business is overspending. A positive net burn rate can also show your small business needs to cut costs or increase revenue. 

On the other hand, a negative net burn rate can mean that a business brings in more money than it spends. The net burn rate should equal the net income on the profit-and-loss statement, and it’s typically expressed monthly.

How can small business owners calculate burn rate?                 

There are a few steps to remember if you want to calculate burn rate as a business owner accurately:

  • First, you’ll look at your cash flow statement. 
  • Second, you’ll pick a time period to measure the burn rate, ranging from daily or weekly to monthly, quarterly, and annually.
  • Third, you’ll determine if you want to calculate the gross burn rate or the net burn rate.

To calculate the gross burn rate, you’ll: 

  • Add all of your expenses. 
  • Divide your expenses by the time periods during measurement. 
  • The gross burn rate will be expressed as a number, most commonly written as months.

To determine the net burn rate, you’ll: 

  • Subtract the beginning cash balance from the ending cash balance. 
  • Divide the cash balance number by the time periods during measurement.
  • The net burn rate will also be expressed as a number, most commonly written as months.

For small businesses, the burn rate could have multiple effects and meanings. Burn rate is a measurement of negative cash flow, so it will detail how much venture capital a small business is spending.

Small businesses with a negative burn rate may be profitable, so it may not indicate business income problems. A positive net burn rate can show that adjustments must occur before the small business closes or runs out of money.

If the burn rate decreases over time with an investment opportunity, investors may want to learn more about why the burn rate isn’t improving. This may also jeopardize investment opportunities if the burn rate doesn’t improve.

Small business owners with a high burn rate may have to make serious decisions before their business loses money. By having a high burn rate over time, some risks that may occur are:

  • Accepting cash or loans with bad financing terms 
  • Acquiring loans
  • Business closure
  • Declaring bankruptcy
  • Launching an initial public offering (IPO)
  • Potential mergers
  • Venture capital funding

Let Us Help You With Cash Flow 

Burn rate plays a significant role in determining the financial standing of small businesses. It’s part of your business’s cash flow, and knowing more about your small business’ cash flow management can make all the difference. 

When you want to work on your small business’s cash flow, consult accountants to help. Work with the professionals at 1-800Accountant for your cash flow management needs.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.