How soon will your startup run out of money?
“A greater output in capital can correlate to a drastic leap up the learning curve as you operate and scale your business. You’ll have to carefully consider what you’re spending money on to decide whether it’s more prudent to save the cash, or scale your growth faster.” – Matthew Toren
To know, you need to understand your startup burn rate. Let’s find out what that means.
Read on to discover the following ‘secrets’ about startup burn rate:
- What “burn rate” means
- The difference between Net Burn, Gross Burn and Runway
- How to calculate these
- Why they matter
What Is Burn Rate?
Your startup burn rate tells you how quickly you’re getting through the money you have in the bank. Typically, that means your venture capital or initial investment.
Usually, the burn rate is expressed in cash spent each month, so a burn rate of $20,000 would mean that your company’s outgoings are $20,000/month. “Runway” tells you how long you could continue at this rate until you run out of money.
Net Burn and How to Calculate It
Net burn rate takes into account cash revenues for that month. You calculate it like this: Spending – Revenues = Net Burn Rate.
If your revenues are higher than your spending, that would give you a negative net burn rate (good job!). So, if you made $30,000 in sales and your outgoings were $25,000, you would have a net burn rate of -$5,000.
Alternatively, subtract the cash balance of your account from that month from the cash balance of the month before. You can also use this awesome free tool.
Gross Burn Rate and How to Calculate It
Gross burn rate doesn’t factor in how much money you bring in each month (or expect to). This is very simple to calculate: you add up all your overheads for that month. If you spend $10,000 each month on office space, salaries and so forth, your burn rate is $10,000.
From here, you can calculate the startup runway. This shows you how long your business could keep paying for your existing monthly overheads with what it currently has in the bank.
Here’s how to work it out:
Runway = Total cash held ⁄ Average burn rate = # months before you run out of money
So, if you have $50,000 in the bank and your average net burn rate is $5,000, your runway would be 10 months. As in, you’d run out of money 10 months from now.
However, you may also want to calculate your runway based on gross burn rate, so that you know how long you’d survive if sales dry up.
So, if you have $50,000 in the bank and your average gross burn rate is $25,000, if you fail to make any sales you’d be bust in 2 months.
Why Track Startup Burn Rate and Runway?
Your gross and net burn rates offer your startup and your investors a reality check.
Gross burn rate helps establish how much you need to bring in each month just to break even. Your gross burn runway shows you how long you’d actually last if sales dried up for a while or you had a temporary cash-flow issue such as late-paying clients.
Net burn rate gives you a clear sense of how well you’re actually doing. You might think sales are strong and your business is thriving when in reality you need to pick up the pace or cut your costs or you’ll run out of money in 6 months’ time.
Many startups are either too flippant or over-cautious about spending money in their early stages.
If they’re wildly optimistic, they may overspend based on predicted revenues without considering how quickly their funds are running out.
On the other end of the scale, they may be terrified to spend, doing everything in-house or with a tiny team, thus limiting growth. A very low startup burn rate could be a handy reminder that they are far from the danger zone and can afford to take risks or invest in technologies and people to help them expand.