Burn rates: what are they?
The burn rate is a measuring tool new companies use to track their negative cash flow. Simply put, it’s the rate at which the startup is spending its venture capital to cover running costs before generating positive income.
To calculate your burn rate, subtract your ending balance from your starting balance and divide it by a time period of your choosing.
Burn Rate = (Starting balance – Ending Balance) / # Months
The burn rate is sometimes considered a significant factor in determining whether the startup will succeed or not. The company uses this rate to determine how much money it can viably afford to ‘lose’ each month to support growth in its technology, sales, marketing, and management divisions.
Excessive expenditure can imply bad planning, and wasted resources that could have better been used to drive new business but being overly cautious also comes with its own drawbacks as a startup may not be aggressively exploring potential revenue streams.
What are the different types of burn rates?
There are different types of burn rates with the below two being the most commonly used:
- Fixed – A fixed burn rate indicates that the company has determined how much money it will spend each year. This type of burn rate is frequently used by startups that are not seeking to raise additional capital.
- Variable – A variable burn rate enables businesses to adjust their spending in response to revenue growth. If revenues grow faster than expected, companies using this method can then choose to increase spending. If revenues fall short of expectations, they may reduce spending.
Why having a high burn rate isn’t always a bad thing
The term “burn rate” sounds intimidating. But, having a high one isn’t always the worst thing.
Funding allows you to increase your burn rate ; and reducing costs should be your last ‘go-to’ when trying to reduce your burn rate. If you’re expanding quickly, investors will want you to spend as they have invested with the objective of growth.
A higher burn rate can suggest the company is ready for a higher valuation, so instead of striving to achieve a low burn rate, re- focus on optimising your burn rate and spending with intention.
Minimising the Burn
Increasing your net worth is the simplest way to minimise your burn rate. Increasing your original financing is a popular tactic used which allows you to spend less on marketing and more on product development.
How to Reduce Burn Rates
Raising more funds isn’t the only way to lower your burn rate, there are other popular ways to reduce your burn rate:
Increasing Revenue Growth
Increased revenue is the simplest method; the goal here is to ensure that your efforts are focused on the ‘quick win’ clients.
If you sell products or services to businesses, focus on finding clients who are eager to do business with you -if you’re selling to individuals, you need to quickly ascertain how to get more individuals to buy, quickly and with minimum spend from your end – this could involve providing discounts and incentive schemes, or providing free demonstrations or samples.
The second way to minimise burn rates is to lower your spending.
You can do this by eliminating costs that are not essential to your core business practice or by re-structuring your staff model. You can easily outsource certain functions of the business to freelancers and consultants.
Wait to make those big purchases
Startup owners need to plan for big purchases, and can only do so when profit and growth are evident.
Although the ‘sky’s the limit’ mentality should apply to innovation, the same thinking can’t apply to spending, or you’ll soon find yourself bankrupt. Focus on ROI-guaranteed resources (return of investment) which can range from simple materials to a talented development team for a software startup.
Your goal should be to cut the company’s burn rate and increase revenue putting you in a position to expand.
Hiring the right people at the right time
One of the reasons startups lose money is because they spend too much on recruitment. First establish your core team and then evaluate your staffing needs.
Initially hiring freelancers can help you keep track of your burn rate – as you evaluate your company’s growth and spending, you can gradually build your in-house team.
The Risk Tolerance of Your Startup
Finally, burn rate is affected by “risk tolerance,” or how willing you are to let your company hit a wall if it’s unable to secure more funds.
Some teams are extremely conservative, preferring to maintain an artificially low burn rate and 2+ years of capital to avoid the sense of a ticking time bomb that is their “cash out” date. Others spend at high levels, seeing rapid growth results, and simply hope that everything will work out.
Whilst risk tolerance will influence your burn rate, you should also consider the risk tolerance of your existing shareholders before making final decisions – after all, the outcomes impact ownership for all parties involved.
Being an entrepreneur comes with its fair share of challenges — watching cash flow, projecting how long funds will last, devoting time to fundraising, and devoting time to customer acquisitions all whilst ensuring you are not neglecting your employees and looking for real business growth are just some of the biggest considerations that entrepreneurs have to navigate.