Completing a successful round of fundraising might feel like reaching a finish line, but securing capital is actually just the beginning of another race. Figuring out what to do with the money you raised is key to scaling your company sustainably.
Smart spending comes down to knowing and managing your company’s cash burn rate. Below, we’ll explain how to calculate your burn rate, why it matters, and what you need to do to manage your burn for better growth.
What is a burn rate?
Burn rate is the rate at which your company spends money after you consider any influx of cash from earnings. It’s usually referred to as a monthly cash amount. For example, if you’re spending $100,000 per month to stay operational (without making any revenue), your company has a burn rate of $100,000.
The difference between your burn rate and total expenses is the assumed lack of positive cash flow. Your monthly expenses tell you how much you’re spending per month without taking revenue or cash flow into account, but burn rate tells you how much money your company can realistically burn through before you need to start generating positive cash flow. In other words, your burn rate is usually all negative cash flow.
Burn rate also gives you another crucial piece of information: your runway. If your burn rate is $100,000 and you have $2 million in funding, your runway is 20 months. That’s the amount of time you can finance operations before you run out of cash.
A burn rate isn’t a perfect measure of your company’s sustainability; a lot of things go into that, including the market, your business strategy, and your product-market fit. But knowing your monthly cash burn is a really helpful way to track your spending and plan for your next round of funding. Your burn rate effectively tells you:
- How much it costs to finance company operations
- How long you can maintain your current spending before you need more funding
- How much time (and cash) you have to continue experimenting with your product
- How your spending translates to output
- How much revenue you need to bring in to start generating a profit in the near future
How to calculate your burn rate
There are two ways to calculate your burn rate, depending on your company’s current growth stage. If you’re not generating revenue yet, you just need to calculate your gross burn. If you’re generating revenue, you’ll want to look at your net burn as well.
Gross burn is your company’s total monthly expenses. You can calculate it on a monthly basis using this formula:
Total yearly spending / 12 months = gross burn
If you spent $750,000 last year on company costs, your gross burn would be $62,500.
Net burn, on the other hand, is your gross burn minus revenue. Here’s a basic formula:
Gross burn rate – monthly revenue = net burn
Using the example above, if your gross burn is $62,500 and you’re bringing in $20,000 in revenue each month, your net burn would be $42,500.
(If you’re ready to move from this hypothetical example and dig into your numbers, we built a burn rate calculator to help you see the exact burn rate for your company.)
How to manage your burn rate
There’s no such thing as a single standard or acceptable burn rate. Your company’s burn rate depends on several different factors that work together, including:
- Your industry
- Your business model
- The state of the market you want to enter
- How much funding you’ve raised
- Your company’s current growth stage
- What your investors expect from you
- How much you need to spend to hit your goals and milestones
Low burn rates are often considered a good thing to aim for—conserve that cash and your company can keep doing business, right? But it’s key to remember that burn rates don’t account for results. If you don’t spend as much as you need to do business, you could fall behind schedule to deliver your product or not be able to market your business effectively.
Instead of trying to keep your burn at an arbitrary threshold, it’s better to focus on knowing what you’re burning and managing your capital wisely—and ensuring your burn rate continues to benefit you. Here are six strategies that can help:
1. Review your financial statements regularly
A reliable accounting system is critical to staying on top of your budget and burn rate. Start by hiring an accountant or financial advisor who’s well versed in venture-backed companies. From there, review your income statement, balance sheet, and statement of cash flow every month in detail.
You’ll want to know how much you’re spending on business-critical things such as customer acquisition cost, revenue growth, product features, and shipping speed. All these documents combined will give you a clear picture of what you’re spending, where you’re spending it, and how much cash you have to play around with.
2. Track your fixed and variable costs
As you start earning revenue or as your revenue grows, your expenses might become more complex. Understanding and tracking your company’s various fixed and variable costs can keep you adaptable as you evolve.
Fixed costs, also known as overhead costs, are costs that stay the same each month regardless of your output or revenue. Your company’s fixed costs might include salaries, office rent, or software subscriptions. Variable costs, on the other hand, fluctuate from month to month; they cover areas like marketing and advertising, inventory, consultant fees, and contractor labor.
It’s a good idea to track both your fixed and variable expenses to see how they’re tied to your company’s growth. As you acquire more customers, for example, you may need to order more inventory, increasing your variable costs. Or you may need to hire another engineer to build out new product features, bumping up your fixed costs.
Regularly reviewing your expenses can tell you whether or not you’re overspending and stretching your burn rate—and if you are, where to cut back. If you can’t afford to scale back on variable costs like marketing, for example, you may have to consider adjusting your fixed expenses, like office rent. Your burn rate (and runway) will change as a result, but that’s OK as long as you’re prepared for the shift.
3. Update your investors with accurate metrics
When your investors ask about your burn rate, what they really want to know is: What are you spending their money on, where is that money taking the company, and when will they see a return on their investment? Put another way: How well are you hitting your targets and maximizing your funding?
If your investors aren’t satisfied with the speed you’re moving at or the decisions you’re making, you may need to rethink your overall burn rate and current cash allocations to make adjustments.
4. Tap into all your resources
Money is only one resource among many. By using all of the resources at your disposal—not just cash—you can maintain a healthier burn rate. One of your biggest resources is your team of investors. If you’re working with a VC fund, for example, you might have access to marketing consultants, event planners, business development experts, or community support staff, all of whom can help you find clever ways to generate buzz and grow without overspending.
Your team’s time, energy, and talents are also valuable resources. If you want to improve efficiency, you may need to restructure your team or redefine roles. Or maybe you need to spend time learning about each individual’s strengths, so you can make better use of their skills and knowledge.
5. Keep adapting
Managing your burn rate is about figuring out what works for your company—and that takes trial and error. You and your team are ultimately the best judges of your spending, so don’t be afraid to reevaluate your strategies and adjust your burn rate to make it work.
As you consider a change in direction or spending, ask yourself the following questions:
- What’s the purpose for this change? Make all your decisions from a place of purpose and logic. Maybe your investors suggested changing focus, or maybe your metrics aren’t where they need to be to support a new round of fundraising.
- Will it help the company reach a milestone or goal? If a change either puts you closer to your next major milestone or closer to an important long-term goal, it’s worth considering.
- What specific value or return on investment will this bring? Consider the quantifiable and non-quantifiable value each change will make. You need to know if you’ll be gaining money, opportunities, credibility, customers, or something else.
Balancing your burn rate
Your company’s burn rate is a good indicator of your spending habits and runway, but it’s not the only metric you should look at when evaluating your company’s growth. To optimize your burn rate, you also have to consider your company goals, your team’s time and energy, and your company’s potential financial future. By looking at your burn rate from all angles, you can set yourself up for better scale—and make sure your burn rate doesn’t burn you.
At Carta, we help startups with fundraising, compensation, valuations, equity management and much more. Talk to us to find out how we can help you grow.