Startup businesses aren’t always successful. When they fail, often it’s due to cash flow issues; 82% of new businesses struggle with cash flow projections. Ultimately, these issues can be severe enough to cause the business to shut down entirely. One study found that 29% of startups fail because they completely run out of money.
Managing cash flow starts with understanding startup’s burn rate. As one founder, CEO, and startup board member noted, “People get into trouble because they plan for what they’ll do with the next funding round rather than plan based on the funding they already have. That next funding round may not happen. Managing burn rate is a way to give yourself options.”
Investors and banks will likely ask for your burn rate when determining how much funding to offer your startup. As a result, it’s worth understanding what this key metric means, the variables that influence burn rate, and how to assess whether your burn rate is healthy or not.
Burn rate is a key performance metric that describes how quickly a startup is spending its initial investment (e.g., venture capital) to finance overhead before generating positive cash flow. Burn rate is simply a measure of negative cash flow.
Burn rate is expressed in terms of cash spent per month. When a startup says its burn rate is $100,000, that means it spends $100,000 per month.
There are two ways to calculate burn rate: gross burn rate and net burn rate.
Gross burn rate can be used to figure out your startup’s efficiency, identify primary cost drivers, and see exactly how much cash is being spent each month. Net burn rate is helpful for long-term decision making, as it allows you to predict your cash runway and strategize your growth plans more accurately.
Burn rate may seem like a relatively simple metric at first, but it’s a powerful way to understand whether your new business is growing or surviving. There are two variables to track that play an important role in a startup’s burn rate: cost of growth and unit economics.
Cost of growth refers to the variable costs that impact operating expenses (e.g., gross burn rate). Cost of growth is mostly impacted by payroll and other employee-related costs, such as benefits, as well as operating expenses, office space, and other variable costs.
The second variable, unit economics, refers to the money earned from each sale. This is calculated by subtracting the customer acquisition cost (CAC) from the customer’s lifetime value (CLV).
Accounting for cost of growth and unit economics enables your startup to understand how much money to raise to cover your burn rate for as long as it takes to meet your growth goals.
If this all seems like a lot of metrics to consider, don’t be alarmed — calculating your startup burn rate is relatively straightforward.
Investors will likely ask for your burn rate to get an understanding of how long your company can spend cash before it runs out. Since most new companies take a while to turn a profit (some never do), a burn rate is an important indicator for fundraising.
Divide the amount of cash you have left by how much you spend every month. For instance, if you burn $25,000 per month and have $100,000 left in reserves, you have four months of runway left.
If you’re seeking to dive deeper, you can start to unpack your cost of growth by understanding the costs associated with your accounts payable. An automated accounts payable platform like Glean AI can give you a comprehensive, full-picture view of your vendor spend.
Glean AI provides FP&A leaders with insight into variable spend. Finance teams can see where your startup’s money has been spent and where it’s going while giving your entire organization what they need to spend intelligently. With our platform, you can understand your budget and where funds should be reallocated to optimize your burn rate.
There is no generally excepted ideal burn rate for a new business. Most experts recommend having at least six to 12 months cash runway at any given time. In practice, that means you would aim for a burn rate that’s one-sixth to one-twelfth of your cash on hand.
Note that many investors will raise alarms over a decreasing burn rate. “Investors give you money because they expect you to spend it,” wrote the experts at HubSpot. “They're investing to accelerate your growth — not to give you a big pile of cash you never touch. So when you secure a capital infusion, you shouldn't be reluctant to increase your burn rate.”
A healthy burn rate is a sign of a growing company. As long as you are managing your expenses responsibly, having a high burn rate can be a good thing. Keeping an eye on spending trends through Glean AI’s centralized dashboard can prevent overspending in one business area that may not be serving your ultimate growth objectives.
To learn more about burn rate and Glean AI, request a demo, today.