Definition: Burn rate is the speed at which a new startup is spending the money raised by venture capitalists before it generates its own operating income. This rate expresses how much money and how fast the company is ‘burning’ through its investors’ funds before creating self-sustaining operations.
What Does Burn Rate Mean?
The burn rate is used to track how much time a company has left before it runs out of funds for its operations and needs to seek out more investors. This rate is usually expressed as a number of months, but in times of severe financial difficulties, it can also be expressed in weeks or even days.
It is imperative for a new company to know its burn rate in order to know how long it can operate if revenues doesn’t grow to a breakeven point and additional capital inflows are required.
Nevertheless, this situation is not always exclusive to new businesses, as large ones can also experience financial problems due to unexpected events or declining market conditions. Investors need to keep an eye on this rate to see if the business is still sustainable or if the risks are too high to keep investing in it.
What’s the Difference Between Gross Burn and Net Burn Rate?
There are two types of burn rates: gross burn and net burn. Gross burn refers to the total amount of operating expenses incurred on a monthly basis. Net burn, on the other hand, refers to the total dollar amount the company loses on a monthly basis.
Let’s look at an example.
KUN Radio is a new radio station operating in Utah. The company has been on the air for only 9 months and is struggling to find advertisers, as its content is not that popular. The business has a gross burn rate of $25,000, a net burn rate of $17,000, and current capital reserves of $120,000.
This means that they have 7 months to either increase revenues before they run out of cash. If they don’t have profitable operations within 7 months, they will have to look for additional cash infusions from investors to remain operational.
Burn rate measures how long a company can continue to operate before it needs to seek additional financing.