How is Burn Rate Calculated?
Understanding how burn rate is calculated is one of the most fundamental skills for startup founders and business owners. Burn rate represents the speed at which a company is "burning" through its cash reserves before generating a positive cash flow.
Knowing your numbers allows you to predict your "Runway"—the amount of time you have left before the company runs out of money. This metric is critical for timing fundraising rounds and adjusting operational expenses.
The Burn Rate Formula
There are two primary types of burn rate: Gross Burn and Net Burn. While Gross Burn looks only at expenses, Net Burn is the more vital metric for survival as it accounts for incoming revenue.
1. Net Burn Rate Calculation
The most accurate way to calculate Net Burn Rate over a specific period is by analyzing the change in your cash balance. This accounts for all cash inflows and outflows.
- Formula:
(Starting Cash Balance - Ending Cash Balance) / Number of Months
Example: If a startup begins the quarter (January 1st) with $200,000 in the bank and ends the quarter (March 31st) with $140,000, the calculation is:
($200,000 – $140,000) / 3 Months = $20,000 per month Net Burn.
2. Calculating Financial Runway
Once you know your monthly burn rate, you can determine your runway. This tells you how long your company can survive at its current spending level.
- Formula:
Current Cash Balance / Monthly Net Burn Rate
Using the example above, if the startup currently has $140,000 left and burns $20,000/month, the runway is 7 months ($140,000 / $20,000).
Gross Burn vs. Net Burn
It is important to distinguish between the two:
- Gross Burn Rate: This is the total amount of operating expenses the company incurs each month (Salaries + Rent + Server Costs, etc.). It ignores revenue.
- Net Burn Rate: This is the actual amount of cash lost per month. It is calculated as
Gross Burn - Revenue.
Investors (VCs) typically focus on Net Burn to understand liquidity, but look at Gross Burn to understand the efficiency of your operations relative to your scale.
Why is Burn Rate Important?
Monitoring this metric helps businesses in three specific ways:
- Fundraising Timing: You never want to raise money when you have 0 months of runway. Knowing your burn helps you start raising 6-9 months before cash runs out.
- Cost Management: If your burn rate is increasing faster than revenue, it serves as an early warning signal to cut unnecessary costs.
- Valuation: Investors use burn multiples to assess if a company is growing efficiently. High growth with high burn is acceptable; low growth with high burn is a red flag.
How to Reduce Burn Rate
If your calculation shows a dangerously short runway (less than 6 months), consider these immediate actions:
- Defer non-essential hires.
- Renegotiate vendor contracts or move to annual plans for discounts.
- Focus marketing spend only on channels with a proven positive ROI.
- Reduce office overhead or switch to remote work.