In the world of business, the scale of your runway is crucial to your success. If it's too short, your company may struggle to take off, while an overly extended runway could lead to poor management and inefficiency.
Burn rates are one way to determine the impact of a technology purchase on financial health as they enable organizations to evaluate alternatives for financing technology. If you're uncertain about how to utilize this knowledge or simply need a refresher on burn rates, this article offers valuable guidance to help secure an adequate runway for your company. Without further ado, let's get started!
Let’s dive in!
What Are Net Cash Burn and Gross Cash Burn?
Whether starting a company or launching a new product, you need to understand burn rates. You can't predict your cash needs unless you know how fast you’re going through your financial resources.
The gross cash burn rate quantifies your monthly operating expenses. It tells you how much it costs to run your business.
The net burn rate looks at income and expenses to determine how much cash the company consumes each month. The gross burn tells you how much you're spending, and the net burn tells you how much money you're losing.
How to Calculate Burn Rates
To calculate your gross burn rate, total your operating expenses for at least three months. Averaging the expenses gives you your gross burn rate or how much you spend each month.
Using the same three-month period, subtract your ending cash balance from your starting cash balance. Divide the result by the number of months.
This number is your net burn rate or money you lose every month. For startups, it is an indicator of negative cash flow.
What Does Gross Cash Burn Include?
Gross burn is your total operating expenses, including the cost of goods sold (COGS). It includes salaries, rent, utilities, and supplies.
Periodic expenses such as insurance and taxes are also part of the calculation. The more months used in the calculation, the more accurate the burn rate, as it will include periodic expenses.
What Does Net Cash Burn Mean?
Burn rate refers to the money a company loses each month. Let's look at some examples.
- Investment Capital. A startup has $1 million of investment capital but no sales. Its operating expenses or gross burn is $50,000 per month. Its net burn is the same, providing a runway length of 20 months. The company's runway is cut in half if the gross burn doubles.
- Investment Plus Revenue. A company receives a second round of funding for $1 million. Its operating expenses are now $75,000, generating $25,000 in monthly revenue. That $25,000 lowers the expenses to $50,000, resulting in a runway length of 20 months. By generating sales, the company extended its runway by almost seven months.
- Revenue. At some point, companies must show a profit if they want to survive. Suppose a company averages a gross burn of $100,000. It has $500,000 in investment dollars and generates $150,000 in monthly sales. Without the sales, the company would burn $500,000 in five months. With sales, the company is not only breaking even but increasing its cash by $50,000 per month for a net burn of -$50,000.
The $50,000 profit translates into a net burn of -$50,000 and extends the runway by two weeks. A negative net burn means a company shows a profit, while a positive burn means losing money.
What Is a “Good” Net Burn Rate?
Experts believe a company should have a runway of at least 12-18 months. For many startups, the length can be as long as 18 to 24 months. For initial funding, you will need forecasted expenses to determine the investment dollars required to operate between 12 and 18 months.
Suppose your projected monthly gross burn rate is $30,000. You will need about $550,000 to survive for 18 months with no added sources of income. If you ask for $600,000, investors will want to know how you plan to spend the added dollars.
Investors will also question a low gross burn rate. If your burn rate is $15,000 instead of $30,000, they may wonder if you are moving fast enough to meet your long-term goals.
What Makes a Healthy Burn Rate?
A healthy burn rate indicates a well-managed company. The company is not only profitable, but it's also sustainable. As cash reserves increase, companies can plan for growth without jeopardizing their runway.
Every company should track its net and gross burn rates. Whether looking for first-round funding or considering expansion, you want to know where your money is going and how long it will last. As your business grows, you will want to know your burn rate to make sound decisions on growth.
How to Reduce Net Burn Rate
Slowing your burn rate comes down to spending less and earning more, but how you do that can take many forms. Here are ways to do so.
Your gross cash burn rate should highlight any increases in expenses. It can also identify where the gains are coming from:
- Direct Costs. Look at raw materials if you're a manufacturer. If you're a retailer, look at inventory. Try to sell off unnecessary raw materials or stock that isn't moving. If you're a tech startup, you may not have excess materials or stock, but you may have other direct costs to reduce.
- Indirect Costs. Look at rent, utilities, and other expenses. It's easy for costs to creep up if not monitored. If you have a large payment due, see if you can negotiate installments. Lower monthly payments can improve cash flow and extend your runway.
Reducing expenses is only half of the equation. You can also look at improving sales.
More sales equals positive cash flow.
Here are a few ideas on how to accelerate sales:
- Email Marketing. Automating emails takes the load off your or another team member’s shoulders. Use software to personalize messages and track engagement to increase conversions.
- Lead Qualification. Use lead qualification software to take the guesswork out of finding prospects yourself. It cuts down on time and has more accurate targeting.
- Upgrades. Added features can help sell existing customers on a product upgrade. If customers have expressed an interest in, or could benefit from, the new feature, they are qualified leads that could increase sales.
- Bundles. Grouping complementary products into a package that sells at an attractive price can accelerate sales of individual products.
- Bonus. Give a slight discount for cash sales or extend a warranty an extra 30 days if customers purchase a minimum order threshold.
- Cross-selling. Consider recommendations at checkout. Display products with “Often bought with this.” If increasing sales is not an option, consider improving operations.
You can make minor adjustments to operations that can help with cash flow
- Invoice Promptly. In the day-to-day chaos of running or starting a business, it's easy to push invoicing aside. However, the sooner you invoice, the sooner you’re paid. Be sure to assess finance charges for late payments to encourage on-time payments.
- Delay Major Purchases. If you have a major purchase planned -- maybe new computer hardware or updated software -- you may need to delay the purchase until your burn rate improves. Or look into specialized financing.
- Pay Bills on Time. You don't want to pay bills late, but you don't need to pay them early. It may not impact your average burn rate but may help with daily cash flow.
How Gynger Can Improve Your Burn Rate
As a startup, you understand the importance of budgeting carefully in the early stages - especially when it comes to pricey software. At Gynger, we enable companies to acquire software with minimal impact to burn rates.
Companies can extend their runways using Gynger’s financing options. By spreading payments out, businesses can purchase the software they need to be competitive without impacting their financial health.
Our flexible payment plans allow companies to break down significant expenses into affordable monthly payments, so there's no need to worry about an immediate financial hit. And because we offer monthly payments, it makes budgeting for software much more manageable. Contact us to learn how Gynger's solution can slow your burn rate.