The rate at which a business uses up its cash reserve in a situation where it is experiencing a loss is referred to as the "burn rate." For businesses, including start-ups, it is a typical gauge of performance and valuation. In its early phases, a start-up frequently struggles to make a profit since it is so busy expanding its clientele and perfecting its goods. As a result, venture capitalists or seed stage investors frequently base their investment decisions on a company's burn rate.
Classification Of Burn Rate
1. Gross Burn Rate
Operating costs are reflected in a company's gross burn rate. It is often measured monthly and is determined by adding up all the business' operational costs, including rent, employee wages, and other overhead. Regardless of sales, it also offers insight into a company's cost factors and efficiency.
2. Net Burn Rate
The rate at which a business is losing money is called the net burn rate. It is determined by deducting operational costs from revenue. It is also assessed once a month. It demonstrates how much money a business requires to stay afloat for a while. But one element that must be managed is the fluctuation in revenue. A higher burn rate can result from a decrease in revenue without an increase in costs.
How To Calculate Burn Rate
You'll need the balance sheet for the time you're evaluating, along with a calculator, to determine your burn rate. Then take the following four actions:
Specify the time frame for your assessment (burn rate is a current metric, so you want to look at a recent period).
Examine your balance sheet to determine your cash position at the start and conclusion of that period (do not use your bank statement as it does not reflect deposits or cheques that have been returned unpaid).
Deduct your starting and ending cash balances from one another.
Multiply the difference by the number of assessment months.
What Are The Implications Of A High Burn Rate?
A corporation may be rapidly exhausting its cash reserves if its burn rate is high. It suggests that there is a greater chance that it will experience financial trouble. Given a specific amount of investment, this may imply that investors will need to set deadlines for generating revenue more aggressively. Alternatively, it can imply that investors would need to give a company more money in order to give it more time to realize revenue and become profitable.
How To Reduce Burn Rate?
1. Layoffs And Pay Cuts
In most cases, if a company is suffering a high burn rate, an investor may negotiate a condition in a funding arrangement to reduce employees or compensation. Larger start-ups that are pursuing a leaner approach or that have recently agreed to a new financing arrangement frequently lay off employees.
A business might forecast growth that will boost its economies. This enhances its ability to pay for fixed costs like overhead and R&D and helps its financial status. For instance, a lot of food delivery start-ups are now losing money. Forecasts for growth and economies of scale, however, inspire investors to provide further funding to these businesses in the hopes that they will eventually become profitable.
Companies frequently invest in marketing to expand their customer base or increase product usage. Start-ups, however, frequently face limitations due to a lack of funding for sponsored advertising. Considering this, the phrase "growth hacking" is frequently used in start-ups to describe a growth strategy that does not rely on expensive advertising. For instance, the engineers at Airbnb modified Craigslist such that traffic from Craigslist was sent to its own website.