Burn Rate: What It Is, 2 Types, Formula, and Examples

What Is Burn Rate?

The burn rate represents the speed at which an unprofitable company consumes its cash reserves. In the case of a startup company, it is the rate at which a new company is spending its venture capital to finance overhead before generating positive cash flow from operations. Thus, it is a measure of negative cash flow.

Burn rate is most often a consideration for young life sciences or technology companies without profits and, in some cases, without revenue. It is usually quoted in terms of cash spent per month. For example, if a company is said to have a burn rate of $1 million, it would mean that the company is spending $1 million per month.

Understanding the Burn Rate

The burn rate is used by startup companies and investors to track the amount of monthly cash that a company spends before it starts generating its own income. A company’s burn rate is also used as a measuring stick for what is termed its “runway”—the amount of time that the company has before it runs out of money.

If a company has $1 million in the bank and spends $100,000 a month, its runway would be 10 months, derived as:

Total Capital ÷ Monthly Operating Expenses = Runway

In this case, that would be:

$1,000,000 ÷ $100,000 = 10 months

How to Calculate the Burn Rate

There are two types of burn rates: net burn and gross burn. A company’s gross burn rate is simply the total amount of operating costs that it incurs in expenses each month, expressed as:

Total Monthly Operating Costs = Gross Burn Rate

A company’s net burn rate, however, is the total amount of money that a company loses each month. This can’t be greater than the gross burn rate, but it can be less.

For example, if a technology startup spends $5,000 monthly on office space, $10,000 on monthly server costs, and $15,000 on salaries and wages for its engineers, its gross burn rate would be $30,000. However, if the company is also producing revenue, its net burn rate would be different, calculated as follows:

(Monthly Revenue - Cost of Goods Sold) - Gross Burn Rate = Net Burn Rate

Let’s say that the above company with a gross burn rate of $30,000 also has revenues of $20,000 a month from selling goods, and let’s put the costs of those goods to the company at $10,000 a month. The company’s net burn rate would be $20,000, derived as:

($20,000 - $10,000) - $30,000 = -$20,000

Even if the company is spending $30,000 every month, the actual amount it is losing per month is only $20,000. This is an important distinction, because it alters the financial runway. If the company had $100,000 in the bank, its runway would be five months rather than three months. The longer stretch of time will affect both how the managers outline the company’s strategy and the amount of money that an investor might be willing to put into the company.

If the burn rate begins to exceed its forecast, or if revenue fails to meet expectations, the usual recourse is to reduce the burn rate, regardless of how much money is in the bank. This requires rethinking the startup’s cost structure and usually means reducing staff and/or other major cost drivers, such as office lease, technology, and marketing.

The Bottom Line

The burn rate is an important metric for any company, but it is particularly important for startups that are not yet generating any revenue. It tells managers and investors how fast the company is spending its capital. The burn rate is used to pinpoint when a company will begin going into debt, expressed as the company’s financial runway. If a burn rate is too high, a company has no choice but to lower its structural costs by reducing what it is spending on staff, housing, marketing, and/or technology.