Calculating Cash Burn Rate
My 18TH, 2017
In a previous post, we talked about Optimal Capital Raise- today I'll write about burn rate, or cash burn rate, which we used as part of the formula to determine your Optimal Capital Raise.
Cash burn rate is typically defined as the amount of cash you are using, or ‘burning’ on a monthly basis. If you had $1mm in cash on January 1st, and now it is April 1st and you have $700,000 left, your burn rate is $100,000/month ($300,000 / 3 months).
Startup CEOs should always know how much cash they have, and at what rate their company is burning cash. This will allow the manager to calculate the date that the company will run out of cash, if it is not operating at cash flow positive.
Let’s take a look at what makes up a company’s cash burn rate. Typically, this will consist of monthly expenses (taken from your income statement), and any outlays of cash for capital expenditures (taken from your balance sheet). Add all of these monthly cash outlays together, and you’ll arrive at a total monthly cash outlay figure. Next, look at revenues (or better yet, revenue less receivables) to give yourself an idea of what amount of cash is flowing into your company on a monthly basis. Subtract this figure from your total cash outlay figure, and this should result in a fairly accurate monthly cash burn calculation.
When looking at expenses, capital expenditures, and monthly revenues, make sure to flag any 'one time’ figures, and exclude these from the calculation. These may be expenses that occur in one month, but will not occur on an ongoing basis (year end accounting expenses, for example), these may be capital expenditures that will not occur on an ongoing basis (purchasing new servers that will not need to be upgraded for an extended period of time), and revenue that will not recur on a monthly basis (implementation/service revenue from onboarding a large new SaaS client).
Most startups burn money during their initial months/years of operations. It is critical to understand the cash burn rate, and be able to predict when/if the company will run into a cash crunch. The analysis will also help inform management as to the optimal capital raise amount that we discussed last week. As a general rule of thumb, I like to see companies raise at least 12 months (better still 18 months) worth of cash. This means that the company will not run into a cash crunch within those 12-18 months, and management can focus on running the business instead of fundraising. Being able to accurately calculate and forecast cash burn rate is crucial to being able to raise the optimal amount of capital, and responsibly manage the business.
