What does burn rate mean?
What does burn rate mean? It’s a measure of how fast your company is spending money.
From this alone, you should appreciate how important the concept is at all levels of business. However, it matters more for startups or SMEs than others.
These businesses often have years of financial loss before breaking even and eventually turning a profit. During this time, their burn rate must be manageable. If it isn’t, there will be difficult choices to make.
How does a burn rate work?
It shows how much cash is being spent during a fixed period. Usually, this period is one month, and we’ll assume that’s the case for the rest of this article.
So, for example, a rate of €10,000 means the company is spending that amount in one month.
We often analyse this metric alongside the amount of time the company has before it runs out of money, which is called the ‘runway’. So, for example, a company with the above burn rate and deposits of €100,000 has a runway of about ten months.
The types of burn rates?
There are two main types:
- The gross burn rate. This is simply the sum of all company expenses per month. It shows how much cash a company will need to meet costs.
- The net burn rate. This is the difference between all monthly revenue and all monthly costs. In other words, it shows how high expenses are when considering income as an offset.
Why should leadership care about the burn rate?
Like many financial metrics, its shows company health in an accessible way.
Startups, and their investors, will be able to see how long the company can last with the money it has.
Therefore it’s crucial for management and directors to ensure that the rate is manageable. Everyone should be able to determine the point at which new income streams need to appear, so the ‘runway’ doesn’t run out.
What happens if the burn rate is not manageable?
If it gets to a point where the runway is exhausted, the company will have to do one of the following:
- Source additional investor funding, utilise any untapped funding channels and explain why the runway was exhausted, why the business still has promise, and the eventual road to profit.
- Make a profit immediately by reducing the burn rate, increasing sales, or both.
How to reduce the burn rate
There are several measures you can take to bring your company into a manageable zone – one that will calm the nerves of investors and management. Keep in mind, though: some of these measures need care in execution.
- Increase sales activity: use (manageable) incentives and other motivational tactics.
- Take out a loan.
- Authorise staff pay cuts or lay-offs.
- Suspend any new hiring until the company is in a more comfortable position.
- Ensure any sales are fulfilled. Startups do not want to find themselves chasing money.
- Suspend buying any significant fixed assets that you don’t urgently need. For example, hold off on purchasing office space or new equipment until you can afford them.
Often, you’ll find that reducing the burn rate is a delicate combination of the above.