Burn Rate:
The burn rate is the rate at which a company uses up its cash reserves to fund its overhead before generating positive cash flow from operations. It's essentially a measure of how quickly a company is spending its available capital.
How to calculate burn rate
1. Determine the time period
Decide the duration over which you want to calculate the burn rate (usually monthly or annually).
2. Calculate total expenses
Add up all expenses during that period, including operating expenses, salaries, rent, and any other recurring costs.
3. Deduct any non-cash expenses
Exclude any non-cash expenses, such as depreciation or amortization.
4. Divide by the time period
Divide the total expenses by the number of months or years in the time period to get the monthly or annual burn rate.
Good burn rate ratio
A good burn rate ratio is one that allows the company to grow sustainably without running out of cash reserves too quickly. This will vary depending on the industry, business model, and growth stage. In general, a burn rate that is lower than the monthly revenue is considered healthy, as it indicates that the company is generating enough income to cover its expenses.
Is burn rate a KPI?
Yes, burn rate is a key performance indicator (KPI) that helps companies track their financial health and sustainability. It provides valuable insights into how efficiently a company is managing its expenses and how long it can operate without generating positive cash flow. Keeping an eye on the burn rate allows founders and investors to make informed decisions about the company's growth strategy, fundraising needs, and overall financial health.
Lets Understand with an example
Harsh is the CEO of a technology startup that just raised $1 million in funding. His company has a burn rate of $100,000 per month, which means that it's spending $100,000 every month to cover operating expenses, salaries, and other costs. At this rate, the $1 million will last for ten months before the company runs out of cash reserves.
In this situation:
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$100,000 is the burn rate:
This is how much the company is spending per month to cover its expenses.
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10 months is the runway:
This is how long the company can operate before it runs out of cash reserves.
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$1 million is the initial funding:
This is the primary source of funding as the business grows.
Hope this was helpful! There's more to explore! Learn about Business-Model here.