Every startup looking to expand its operations or demographics needs some good amount of money to fund it. As they delve into it further, the burn rate increases substantially.
Burn rate is measured and monitored by startups as one of the most important metrics.
This refers to the rate at which a startup spends its cash to finance overhead before generating profits from operations.
Why do startups calculate Burn rates?
The burn rate is like a measuring tool for the company’s runway. It helps in calculating and understanding the time the company has before it runs out of money.
For example, if the company has a runway of $10 Million, the company runs on a burn rate of $1 Million in its initial month, its runway will be at a maximum of 10 months.
Maximum startups fail because they run out of money. Hence, it is very important to understand the run burn rate and runway for any company.
Types of Burn Rates?
There are 2 types of burn rates that a company can monitor, they are categorized as:
- Net Burn Rate
- Gross Burn Rate
The Net Burn Rate is calculated by subtracting the expenses from the revenue. It helps in understanding the speed at which the startup is utilizing its venture capital, in correspondence to the revenue the company is generating.
For example, a company is spending $50,000 a month on its operating expenses and is generating a revenue of $20,000 a month. Therefore, we will calculate the net burn rate by subtracting the revenue from the expenditure.
Operating Expenses: $50,000
Net Burn Rate: $30,000
The Gross Burn Rate is an addition of all the expenses the company is bearing. This may include everything from salaries, rent, overhead expenses, travel, training, packaging etc. This is calculated on a monthly basis. In case you would want to calculate the gross burn rate on the fourth month of operations, you can divide the expenditure of 4 months by 4.
Total expenditure of 4 months: $1 Million
No of Months: 4
Gross Burn Rate: $250,000
What is an ideal burn rate for any startup?
The ideal burn rate, is wherein the company can maintain a runway of 6 months before it completely runs out of its venture capital. This is the minimum a company should plan to be able to stabilize itself in situations of changing revenue outcomes and other environmental factors.
Though every company is different and what works for one, may not work for another. However, experts strongly suggest any startup at least maintain a runway of 6 months, if you are hoping for planned outcomes.
Always keep in mind that your startup’s survival is closely related to your cash runway. When you run a startup, the money that you have ultimately matters more than any money you’ll (potentially) make.
How do companies control the burn rate efficiently?
Understand your stage:
Companies need to make wise decisions at the time of hiring staff. If your product is at the manufacturing stage, you may not need any sales personnel at that time. Plan hiring in a way that the required team is available and trained only by the time required.
Understand your product and its target audience. A digital marketing platform allows companies to target and sell to a specific target audience. You can form segmented groups on google ads manager and market your product in a smart way, ensuring judicial use of resources.
You may create a strong team, but not a smart team. A smart team comprises of multi-taskers, who can be put to use when there is less demand for the portfolio they are hired for. When hiring a CEO, ensure the candidate not only does operational planning, but also support designing.
Companies often plan to offer a variety to their customers, so that the customer takes them seriously. They may plan a complete range of products. However, it’s an advisable option to halt production of the products that don’t sell. It is wise to increase production of those products that sell more. This will help in avoiding wastage and creating a line of bestsellers and accordingly the marketing strategies can be rethought.
When you constantly monitor your burn rate, you will understand the finances and the base of your startup, where the numbers are going, the high-expense areas, the heavy load departments and the growing churn rates.