You’ve started a new business and, hopefully, you’ve managed to secure some funding to get it off the ground.
You need that money to cover overheads before your business becomes profitable. This applies to all sizes of startups, from tiny one-person initiatives to much larger companies that need to pay for office rentals, employees’ salaries, and more.
Burn rate is, as you might guess from the name, the rate at which you “burn” through your startup funding. It’s normally calculated per month.
For instance, a business spending $10,000/month that hasn’t yet made any profit has a burn rate of $10,000/month.
A business spending $10,000/month that brings in $4,000/month from sales has a burn rate of $6,000/month.
(If you’re still trying to get your head around it, you might want to read more about burn rate calculations.)
Obviously, your business can’t keep burning money forever. If you’re running at a loss, you’ll quickly use up all your initial capital.
Along with burn rate, there’s an important concept called your “runway”: the amount of time you have left before you’re out of cash.
For instance, if your burn rate is $6,000/month and you have $18,000 left in the bank, then you have a runway of three months.
You might think a three-month runway is sufficient – particularly if you’ve seen month-on-month growth – but most entrepreneurs should have six months (or more) of runway available at all times. This means that if something unexpected happens, you’ll be able to handle it.
There are a couple of ways to increase your runway if it looks like you’re heading for a crash:
- Increase your available funding
- Improve your burn rate
While many entrepreneurs seek an additional loan or even turn to credit cards, more money in the bank won’t necessarily help them turn things around. If your burn rate doesn’t improve, you’ll quickly find that this money disappears too.
So, instead of or in addition to extra funding, you’ll want to look at improving your burn rate.
How to Improve Your Burn Rate
Obviously, you could improve your burn rate by making more sales each month – but you’re probably doing all you can on that front already. Plus, efforts you make now (like doing lots of marketing) may not pay off for several months.
A quicker way to improve your burn rate is to ruthlessly cut your monthly expenses. That might mean making hard decisions, like letting employees go or giving up the fancy office you rent so you can work from home instead. But making those decisions now could be what saves your business a few months down the line. For more on this, Mike Michalowicz’s books The Toilet Paper Entrepreneur and Profit First are great reads.
It’s important to be proactive about monitoring your burn rate, as expenses and income fluctuate for your business.
Don’t just keep spending on the grounds that you have a lot of money sitting in the bank – pay close attention to how quickly you’re getting through that money … and to what will happen if your cash flow forecast proves a little optimistic.