Running out of money is every startup’s worst nightmare. But it happens. Situations like insufficient funding, economic recessions, or costly scaling can all negatively impact a startup’s success.
How do you avoid these situations, and how can you better track your expenses? The answer lies in your cash burn rate.
Knowing how to calculate the burn rate will help you keep track of your expenses using your income statement. There are two types of burn rates to know: gross burn and net burn. These rates will give you an idea of how much you're spending in total and how much you're losing after revenue.
In this blog post, we'll break down what gross burn and net burn mean, how they differ, and how to calculate them. We'll also discuss why understanding these cash burn rate formulas is so vital to the success of your business.
Gross Burn Vs Net Burn
A startup's burn rate indicates how quickly cash reserves are used before starting to achieve profits.
Knowing how to calculate cash burn is essential for financial stability in the early days and beyond. But to do so, startup founders must first understand two critical types of burn rates: gross burn and net burn.
What Is Gross Burn?
Gross burn is the sum of all operating expenses your company incurs monthly. You'll find these expenses — including everything from payroll to rent to utilities — on your income statement.
Monitoring your company's gross burn allows you to see what you're spending each month. It can also help you understand the amount of cash required to maintain operations without taking into account your revenue streams.
How To Calculate Gross Burn
To calculate the gross burn, you must add all your monthly expenses, including rent, income, and other overhead costs.
Gross Burn = Monthly Operating Costs
For example, if your total monthly operating costs are $10,000, your gross burn rate is $10,000. That means you're spending $10,000 monthly to keep your startup running.
What Is Net Burn?
Net burn is the total amount of money that your company loses each month. It's an especially crucial financial metric for startups or businesses operating with negative cash flow, as it indicates how quickly they're using available funds.
Net burn accounts for income in addition to expenses. That's why it can vary based on revenue fluctuations. Net burn is usually the same number as your net income.
How To Calculate Net Burn
To calculate your net burn rate, you must look at your operation's cash flow. Subtract your monthly operating expenses from your monthly revenue to get your cash balance.
Net Burn = Monthly Revenue - Monthly Operating Costs
For instance, if your business brings in $10,000 in monthly revenue and has operating expenses of $8,000 per month, your net burn is $2,000.
Gross Burn Vs Net Burn: Key Differences
To better understand gross and net cash burn, let's look at some key differences in how they're calculated and used.
To calculate your current burn rate, you'll use the two formulas for the burn rate mentioned above. While both calculations measure the negative cash flow of a business, there are some key distinctions to keep in mind.
Gross burn refers to the total cash a business spends each month, while net burn involves subtracting costs from cash inflows. If your business generates revenue, your net burn will be lower than your gross burn.
Inclusion Of Revenue
Gross burn refers to the total amount of money a company spends, including operational expenses, salaries, and other costs.
On the other hand, net burn will tell you the amount your company loses each month after factoring in revenue.
If your company is burning through cash faster than it's bringing money in, your net burn will show a negative cash flow. In contrast, a positive cash flow means you're generating cash at a faster rate than you're using it.
Understanding the difference between gross and net burn can go a long way in ensuring the long-term sustainability of your business. By keeping an eye on both of these numbers, you can monitor the financial health of your business.
Gross burn helps you identify areas where you may be spending too much and adjust accordingly.
Whereas net burn measures how much funding you need to keep your business running. It can give you an idea of your startup runway, which is how long you can continue operating before running out of cash. If your net burn is high, you may need to prioritize cost-cutting or fundraising.
Your Average Burn Rate Impact On Potential Investors
When pursuing capital for your startup, investors will consider your cash burn rate to determine your financial health, efficiency, and growth potential. Your burn rate helps determine your cash runway so you can illustrate how quickly you're spending your startup budget.
Demonstrating that you have a solid understanding of your financial projections and a plan for how to reduce your cash burn rate makes your startup more appealing to potential investors.
Ultimately, you can lay the foundation for long-term success by controlling your burn rate and being transparent with investors.
The Importance Of Tracking Your Cash Burn Rate As A Startup Owner
Understanding how to calculate your burn rate can prevent the risk of running out of money. By using both gross and net burn rate formulas, you can determine your startup runway.
Then, you can see how long your company can sustain its current spending before running out of cash and strategize accordingly.
By keeping tabs on your startup burn rate, you can make informed decisions about budgeting, investments, and sustainably pacing your company's growth. Don’t let your cash burn rate become a mystery — instead, use it as a tool to build a profitable company.
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