date: 2021-06-13 21:12:58
The burn rate is one of the most significant and simple metrics used by investors and startups.
In general, there are two types of burn rates:
The burn rate is essential to understand the runway available for the company, which is the time left to survive based on the expected burn rate in the coming months. To calculate the runway available in months, the estimated cash burn for the coming months is divided by the currently available cash balance.
In the startup world, the cash inflows are named revenue, while, cash outflows are expenses.
As an example, to calculate the net burn rate, let us assume your company has USD1,000,000 in your bank account at the beginning of the year, at the end of the year your cash balance became USD700,000 and your company’s revenue during the same year was USD200,000. This means that your monthly net cash burn was USD1,000,000 minus USD700,000 (USD300,000) divided 12 months equals USD25,000. On the other hand, the monthly gross burn rate will be USD1,000,000 plus USD200,000 minus USD700,000 equals USD500,000 divided 12 months is USD41,660.
In other words, your gross burn rate is the total expenses incurred, while, the net burn rate is the net loss.
So, what does the net cash burn actually mean? It provides an estimate on how long would the startup actually survive. Continuing on the above example, assuming that your company is estimated to have the same level of revenue and expenses going forward, that means that at the end of the year, your company is expected to “survive” for the next 28 months (USD700,000 divided by USD25,000).
Usually, the parties normally most interested in the cash burn are company owners and investors, which unsurprisingly, are the most concerned in the survival and success of the company.
So now you understand what a cash burn means. How do you control it? The first step is to understand the stage in which your company is at, for example, avoid investing heavily in hiring additional employees or performing aggressive marketing plans until you know that you have validated your product, meaning that you know that your product is actually something people want and that it is a product that can potentially scale.
This involves various elements, which most importantly means talking to your users and understanding their requirements and iterating your product accordingly. Usually, this entails the co-founders / founder performing various tasks in different departments, which includes managing the product, customer support, marketing, fundraising and any other administrative work required.
In summary, although cash burn rate is a vital metric you should not get obsessed about it and should remain open toward opportunities that may arise along the way. For example, investing in a marginally more expensive employee could be defensible if they are a fit in the company and can truly assist in scaling the business.
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