When you're running a startup and your main priority is to scale and expand, explore when it makes sense to hire a financial controller and other options you may consider.
Monday, May 18, 2020
Burn rate is the rate at which a company is spending or losing money. The three most common types of startup burn rate calculations are cash burn, gross burn, and net burn.
For startup founders, understanding burn rate is critical to building and growing a business; it's the foundation for understanding startup runway (more on this later) and helps determine the amount of money in VC funding you require.
Cash burn rate is the change in cash balance month over month.
Cash burn rate takes total cash balance from the prior month minus the cash balance in the current month to determine your current cash burn rate. Beware that including VC-funding in your cash burn rate calculation does not always give you a realistic view of how much money is being spent/lost, and may lead to cash burn issues down the line.
For this reason, venture capital-backed startups may wish to exclude recent VC funding from this calculation. To do so, the calculation would be:
To find your average cash burn rate, add up the results of your monthly calculations, and divide by the number of months included. For example:
This calculation can be used to determine your average burn rate across cash burn, gross burn or net burn; just swap out the figures accordingly.
While the concept of change in cash balance from one month to the next is a straightforward take on measuring burn rate, it does not take into account more 'common sense' elements of bookkeeping and the accrual accounting method most startups use. The cash burn rate method often leads to more questions and confusion about the company's burn rate as it relates to the P&L.
With the Zeni Dashboard, customers can easily view change in cash position month over month (or by weeks, quarters, or years) within the Cash Position report, keeping an eye on the actual rate of change in this category regularly.
Gross burn rate is the total amount of cash you're spending per month.
Gross burn is a more literal calculation of outgoing cash, combining all of your monthly expenses as found on your income statement (P&L) to determine your burn rate. To find your average gross burn rate, add up the results of your monthly calculations, and divide by the number of months included.
Prominent tech venture capitalist Fred Wilson breaks it down saying, "You look at your monthly expenses on your income statement. Add all of them up. And then look at any outlays of cash for capital expenditures or other regular uses of cash on the balance sheet and cash flow statement. Add all of these monthly cash outlays together. This is 'gross burn rate'."
Staying on top of your operating expenses is crucial. For Zeni customers, the Zeni Dashboard shows your company's gross burn rate via the Operating Expenses report, which organizes various groups of expenses, from Salaries and Benefits to Sales and Marketing, including Cost of Goods Sold (COGS).
But basing your company's burn rate on spend alone does not result in the most powerful figure to determine burn rate.
Net burn rate is the total amount of cash you're losing per month.
The net burn rate factors your total expenses and total income in a given month, including proceeds from revenue and cost of sales, to determine burn rate. This is the same figure as Net Income on your monthly P&L statement.
To find your average net burn rate, add up the results of your monthly calculations, or monthly Net Income figures from your P&Ls, and divide by the number of months included.
Mark Suster of Upfront Ventures explains, "The reason that most investors quickly zero in on net burn is that if you have $3 million in your bank account and have a net burn of $150,000 per month you have more than 18 months of cash left provided your net burn stays constant. Conversely if you’re burning $600,000 per month (yes, some companies do) then you only have 5 months of cash left. It’s what signals to existing investors how quickly their teams need to be fund raising and the level of risk the company is facing and also it signals to potentially new investors both how quickly you need to raise (ie you have less leverage if you’re in a rush) as well as how much cash you’ll need if they fund you."
When comparing the three aforementioned methods of calculating burn rate, we determined the net burn rate calculation provided the most realistic and simplified interpretation of startup burn rate for our customers.
Each month, our customers receive their Zeni Report which clearly outlines their average net burn rate, runway, revenues, cash in hand, and headcount (another important figure for founders to know off the top of their head). And soon, Zeni customers will have access to their detailed net burn rate via the Zeni Dashboard.
See also: 8 Best Accounting Tools for Startups
Burn rate and startup runway go hand in hand. Your burn rate calculation can be used to quickly determine your company's cash runway, or how long your company can operate at its current rate before running out of cash.
Use your average net burn rate and current cash balance to determine how many months your company can continue operating before it tunes out of cash.
At Zeni, we use the average net burn rate of at least the past three months in this calculation to take into account the increase or decrease in the burn rate month over month.
You now know everything there is to know about understanding and calculating startup burn rate and runway, and can determine the best type of burn rate calculation for your startup or small business.
Looking for someone to calculate your burn rate and manage your startup's finances with attention to detail, speed, and ease? Give Zeni a try.
At Zeni, we offer a team of finance experts working seamlessly with powerful artificial intelligence — both dedicated to managing every financial function for your business with speed and accuracy. We offer best-in-class service and pricing for monthly accounting and bookkeeping services, plus a flat fee of $2,000 to complete our customers' year end taxes. Learn more and try Zeni today.