Burn Rate: What It Is and How to Calculate It

Managing your startup's finances effectively can be the difference between thriving and running out of cash. One critical metric every founder should know is burn rate- the rate at which your company spends capital to stay operational. Calculating and controlling burn rate helps you forecast your financial runway, optimize spending, and avoid unexpected cash crunches. This guide will break down burn rate, how to calculate it, what a good burn rate looks like, and best practices for keeping it under control.

What is Burn Rate?

Understanding your startup's burn rate is crucial for effective financial management and long-term success. Burn rate refers to the pace at which a company consumes its cash reserves to cover operating expenses before generating positive cash flow. Monitoring this metric helps founders assess their financial runway- the time a company can operate before needing additional funding or achieving profitability. By keeping a close eye on burn rate, startups can make informed decisions about budgeting, scaling operations, and fundraising strategies.

Gross Burn Rate

Gross burn rate represents the total cash outflow a company incurs monthly to fund its operations, excluding any revenue generated. This includes all operating expenses such as salaries, rent, utilities, and other overhead costs. Calculating the gross burn rate provides insight into the company's spending habits and cost structure, serving as a baseline for evaluating financial health.

Net Burn Rate

Net burn rate accounts for the company's revenue, reflecting the actual monthly cash loss after subtracting total revenue from total expenses. This metric offers a clearer picture of how quickly a company is depleting its cash reserves, considering both income and expenditures. Monitoring the net burn rate is essential for understanding the sustainability of current operations and planning for future financial needs.

By differentiating between gross and net burn rates, startup founders can gain a comprehensive understanding of their financial standing, enabling them to make strategic decisions to extend their runway and achieve long-term success.

How to Calculate Burn Rate

Now that you understand what burn rate is and why it’s crucial, let’s explore how to calculate it. There are two main types of burn rates to consider: gross burn rate and net burn rate. Both metrics help provide a snapshot of your startup’s financial health, but they serve different purposes. Gross burn rate focuses purely on expenses, while net burn rate factors in revenue. Here's how to calculate each type.

Related resource: How to Calculate Runway & Burn Rate

Calculating Gross Burn Rate

Gross burn rate refers to a startup's total operating expenses within a specific period, usually calculated monthly. It includes costs such as salaries, rent, utilities, and other overhead expenses. This metric highlights how much cash the company spends to keep operations running, independent of any revenue. Understanding gross burn rate helps identify key cost drivers and assess operational efficiency.

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Calculating Net Burn Rate

Net burn rate measures how quickly a company is depleting its cash reserves after accounting for revenue. It’s calculated by subtracting monthly revenue from monthly operating expenses. This metric reveals how much cash a startup needs to sustain operations each month. However, since revenue can fluctuate, it’s essential to monitor this variability. If revenue drops while expenses remain constant, the net burn rate will increase, potentially shortening the company's financial runway.

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What Is a Good Burn Rate for a Startup?

Determining a "good" burn rate for a startup depends on several factors, including the company’s stage, industry, available funding, and growth objectives. Early-stage startups typically have higher burn rates as they invest in product development, marketing, and team expansion. Whereas, more mature startups might aim to control burn rates while focusing on achieving profitability.

Key factors to consider:

Startup Stage:
- Pre-seed and Seed Stage: Burn rates are often higher due to heavy investment in building and launching the product.
- Series A and Beyond: Companies might balance growth spending with a path toward profitability, making cash efficiency more critical.
Industry Norms: Industries with longer development cycles, like biotech or hardware, may experience higher burn rates compared to SaaS or e-commerce startups.
Funding Availability: Startups with recent funding rounds may sustain higher burn rates to accelerate growth. A common guideline is to ensure your burn rate allows for at least 12-18 months of runway between funding rounds.
Growth Goals: High-growth startups might intentionally maintain a higher burn rate to capture market share quickly, while those focusing on sustainability may aim to keep burn rate low to extend their runway.

Ultimately, a good burn rate balances growth ambitions with financial sustainability, ensuring your startup doesn’t run out of cash before achieving critical milestones.

Related resource: Startup Metrics You Need to Monitor

Best Practices for Managing Burn Rate

Effectively managing your burn rate is essential to ensure your startup's financial health and longevity. By keeping your burn rate under control, you can extend your runway, make the most of your funding, and improve your chances of reaching key milestones. The following best practices will help you optimize spending, increase operational efficiency, and reduce the risk of running out of cash.

Regularly Review and Adjust Budgets

Frequent budget reviews are essential for keeping your startup's finances aligned with your current goals and market conditions. By revisiting your budget regularly- ideally monthly or quarterly- you can identify overspending, adjust for unexpected expenses, and reallocate resources to areas that drive growth. This practice helps you stay agile and responsive, ensuring your spending reflects your startup's strategic priorities. Consistent budget assessments also make it easier to anticipate financial challenges and adapt quickly, reducing the risk of depleting cash reserves unexpectedly.

Optimize Operational Expenses and Identify Unnecessary Costs

Streamlining your operational expenses is a key strategy for managing burn rate effectively. Start by analyzing all business expenses to identify non-essential costs that can be reduced or eliminated. Consider the following strategies:

Negotiate Contracts: Review contracts with vendors, landlords, and service providers to secure better rates or more favorable terms.
Embrace Automation: Implement tools and software that automate repetitive tasks, saving time and reducing labor costs.
Remote Work Flexibility: If possible, reduce office space or shift to a remote-first model to cut rent and utility expenses.
Monitor Subscriptions and Tools: Eliminate unused or redundant software subscriptions and services that drain resources without adding value.

Diversify Revenue Streams to Reduce Reliance on External Funding

Relying solely on external funding can leave your startup vulnerable to market fluctuations and investor sentiment. By developing multiple revenue streams, you create a more stable financial foundation and reduce the risk of cash flow gaps. Consider these strategies for diversification:

Explore New Customer Segments: Identify additional markets or demographics that could benefit from your product or service.
Offer Complementary Products or Services: Introduce new offerings that align with your core business to increase revenue potential.
Adopt a Subscription or Recurring Revenue Model: If applicable, recurring models can provide predictable and steady cash flow.
Create Strategic Partnerships: Partner with other businesses to cross-promote services, expand distribution channels, or bundle offerings.
Monetize Existing Assets: Leverage data, content, or intellectual property to create new revenue opportunities, such as licensing or premium features.

Monitor Cash Flow Projections Alongside Burn Rate

Combining cash flow projections with burn rate analysis is essential for maintaining financial control and making informed decisions. While burn rate shows how quickly your startup is depleting its cash reserves, cash flow projections estimate future inflows and outflows based on current trends and planned activities. Together, these metrics provide a comprehensive picture of your financial health.

Why it matters:

Identify Potential Shortfalls: Projections help you foresee periods when expenses might outpace income, allowing you to take corrective action early.
Plan for Fundraising: Knowing your projected runway helps you time fundraising efforts to avoid running out of cash.
Adjust Strategies in Real-Time: By tracking both metrics, you can quickly adapt spending plans, delay non-essential expenses, or accelerate revenue-generating activities.
Improve Decision-Making: Informed by data, you can confidently decide when to invest in growth initiatives and when to tighten spending.

Track Your Key Startup Metrics with Visible

Understanding and managing your burn rate is essential for keeping your startup financially healthy. Calculating gross and net burn rates, reviewing budgets, optimizing expenses, diversifying revenue streams, and monitoring cash flow projections can help you make informed decisions and extend your financial runway. Staying on top of these metrics also helps you avoid unexpected cash crunches and ensures you're prepared for growth.

Tools and software are a great way to keep tabs on your finances. Track key metrics, send investor Updates, and track the status of your next fundraise with Visible. Give it a free try for 14 days here.