Calculate your cash burn rate

A startup’s burn rate is effectively the amount of money it is spending in excess of its revenue every month. There are a couple of different ways to calculate burn rate. The easiest method is to take the average decrease in the company’s cash position over the past several months - exclusive of any financing events. For example, if a company had $300,000 in the bank, then $275,000 the next month, then $250,00 the last month, then the metric would be $25,000 a month. 

Don’t forget to include other, non-checking account balances. Your payment processor, a money market account, a saving account, etc. all likely contain dollars that should be included in the analysis.

Two Ways to Calculate Cash Burn Rate

Let’s dive into the two ways experienced CFOs use to understand burn rate.

One method of calculating burn rate uses a startup’s income statement. Income statements show a company’s income and expenditures, and follows a formula: Net Income = (Revenue + Gains) – (Expenses + Losses). Normally your startup accountant sends you an income statement every month, so one way to determine the metric every month is to just look at the net income on your income statement - and that’s conceptually how much your bank account balance should be decreasing every month..

However, your income statement will also include things that are accrued, as well as items that are capitalized. Accrual accounting recognizes revenue when it’s earned and records expenses when they are incurred, rather than when money changes hands. So a SaaS company that signs a 1-year, $60,000 contract to provide services for a year would recognize $5,000 each month, even if the customer paid the full $60,000 at the beginning of the year. A startup that invests heavily in equipment will capitalize those expenses, and expense the cost over the useful life of the equipment, even though the startup paid for the equipment in full. So the income statement doesn’t necessarily show how much actual cash the startup has at a particular moment.

Calculating a cash burn rate using a startup’s cash flow statement gives a different picture, and at Kruze Consulting we calculate our clients’ metrics both ways. The cash flow statement shows the actual amount of money that  is entering and leaving your startup in a given period, and shows you how much cash your startup has on hand at a given time. Typically startups have a negative cash flow because they don’t make money in their early years. The negative total from the cash flow statement is how much money the startup is spending each month. 

One easy way to calculate cash burn using the cash flow method is to take the ending bank balance from the prior month and to subtract it from the ending position of the current. This formula will yield the cash burn for the month.

With both the income statement and cash flow methods, you’ll need to average the numbers over a specific period to get a burn rate. For many companies, we calculate the metric on a six month average. That “smooths out” a lot of the spending and gives a good picture of the company’s actual burn rate. Some companies prefer a three-month average, which will show more of the spending ups and downs, and makes sense if you are rapidly growing revenue, adding headcount, etc. But whichever method you choose, you should look at it every month. It’s a good idea to provide that information to your board of directors, as well.

Gross burn rate is the most conservative way for a startup to calculate your monthly net cash out the door. Your gross burn rate is essentially all the money the company spends each month, including operating expenses, taxes, registrations, etc. Some people like to add in any capital expenditures, which is perfectly valid. But the gross number does not include any revenue, which is why it provides the most conservative cash-out date for startups.It’s the total amount of money going out the startup’s door each month.

The biggest tip we can offer to founders looking to control and manage their cash burn is to maintain a detailed financial model that forecasts monthly expenditures, including staffing costs. Your financial model shouldn’t merely be an accounting task but should incorporate key performance indicators (KPIs) that serve as a health check for your business.

A proven method many successful startups employ to regulate their cash burn rate is to link any escalation in expenses to the achievement of specific milestones or KPIs. Each new team member or subscription service you add has a compounding effect on your monthly cash outflow, thereby increasing your burn rate. By correlating significant spending hikes to clear-cut KPI goals, entrepreneurs can exercise better financial stewardship over their company’s resources.

For instance, you might decide not to bring on a third sales representative until one of your initial reps demonstrates they can meet sales quotas without requiring the founder’s direct involvement.

Benchmarks to Use to Gate Burn Rate

Other benchmarks you can associate with upticks in expenses may include:

- Evidence of product-market fit
- A defined number of customers
- Regulatory clearances
- Demonstrable sales and marketing alignment
- Momentum in releasing new features
- Retention of major clients

This approach is particularly effective during challenging financial climates, like recessions, where capital is harder to secure.

So again, gross burn rate is the worst case scenario for your cash out date, and net factors in estimates for any income. Both are good to know – you don’t want to kid yourself and you really want to have that honest look at your cash position and how much runway you have. If you have other questions on calculating or managing burn, cash out dates, or runway, contact us.

Gross Burn: Your business’s monthly expenses

In simple terms, the gross burn rate is the total amount of money your startup spends each month. The gross burn rate includes costs such as salaries, office rents, utilities, and other operational costs. For most businesses, cost of goods sold is negligible and is ignored. 

One huge item to note with the gross calculation is that it doesn’t include any cash inflows - only expenses. 

This is actually a feature of the calculation - it gives founders a view into the company’s total expenses, and when used in a runway calculation tells a founder how long the company has to live if revenue dries up (or never materializes). Having an exact sense of monthly spend is very valuable. 

Your gross burn rate is calculated by adding up your total monthly operating expenses. It’s crucial to maintain a clear record of all your expenses and update this regularly to have a precise gross burn rate.

Net Burn: A good calculation of financial health for stable companies

Net burn, on the other hand, offers a more complex but comprehensive view of your company’s financial health. It’s the total amount of cash your business is losing per month. Unlike the gross burn, the net burn rate considers both your total monthly expenses and your total revenue.

In essence, the net burn rate is an accurate reflection of your cash flow. It includes your revenue and cost of goods sold (COGS) in addition to operational expenses. Net burn offers a comprehensive perspective of your current financial situation. It makes the most sense to use for a company that is reliably producing revenue. 

However, in a situation where you may lose clients, it can be a misleading view into how much your company is spending per month, and thus can give you an overly optimistic view into your runway. For companies that are seeing a lot of churn, who are navigating a downturn or who are facing uncertain times, founders should have a strong handle on the gross burn number. 

To calculate your net burn rate, take your total monthly revenues, subtract the total monthly cost of goods sold (COGS) and total monthly operational expenses. This is basically an EBITDA calculation, which is something non-tech companies use regularly as an important metric for cash production. 

Accrual accounting, which is generally preferred by investors and board members, forms the basis of net burn calculation. It offers a consistent calculation that’s contextually aligned with your financial records, making it a preferred choice for financial stakeholders. 

Wrapping Up: Gross Vs. Net Burn Rate

While both gross and net burn rates are critical financial metrics, they offer different perspectives of your company’s financial state. Gross burn provides an understanding of your total monthly expenditure, whereas net burn paints a more nuanced picture of your financial health by considering both revenue and expenses.