If you are looking to obtain money from a venture capital firm, you may be asked the question, “so what is your expected burn rate?”
The burn rate is simply a calculation of the amount of cash that a start up business spends each month. Usually, the burn rate is based on the assumption that a new business will spend start up capital at a loss for some time before profitability and positive cash flow occur.
The burn rate is a critical measurement of the potential financial health of a start up, as well as how much start up capital may be required before profitability begins.
Calculating the Burn Rate
A new business owner may simply want to say that the burn rate is an average of typical monthly costs. However, one needs to consider what other sources of cash (not necessarily revenue), are available as well.
Consider a burn rate to be in terms of negative cash flow. For instance, the following simple formula helps provide the monthly cash flow:
All sources of current and expected income or revenue (not current cash on hand) LESS: Monthly operating costs, including interest and taxes (but not including depreciation or amortization
= BURN RATE (NOTE: Cash flow will probably be negative for start ups)
If the start up does have some cash available, such as loans from family and friends or other angel investors, the “Cash Zero Date” is the date in the future when the cash runs out. For instance, if the burn rate is $50,000 per month, and there is $150,000 in the bank, the Cash Zero Date would be three months in the future ($150,000 / $50,000)
Managing Your Burn Rate
It is important to have the burn rate calculation ready to present to venture capital firms. Some firms will want to know all future burn rate expectations. For instance, when the product is ready to be promoted “live” to the public, you may be in a position to hire more people, causing an increase in the burn rate before actual revenue is expected.
Of course, it is best to learn how to control expenses and keep the burn rate as low as possible. Constantly monitor expenses month-by-month, and continually compare actual expenses to the predicted ones. If a venture capital firm knows that you are in control of your burn rate and have predictions in the future that protect their investment and lower their risk, you’ll have a much better chance of approval.