Burn rate is one of the most important metrics used to judge the health of a startup. In a startup scenario, where almost the entire capital is infusion from investors, it is very important for them to know how much money invested by them has been consumed and at what rate. It also helps the business to roughly figure out the time when the company will run out of funds.
Burn rate, as the name suggests, is the rate at which the cash is burnt in the company. It is actually a term used in chemistry to measure the linear combustion of a solid propellant.
Burn rate, also called cash burn rate, is the speed at which the cash available with the startup has been consumed.
If the company had Rs 5 crore cash on Jan 1, and as on Oct 30 is left with Rs 3 crore, the burn rate of the company is Rs 2 crore/10 or Rs 20 lakh per month. That is, Rs 2 crore of cash went out of the business at the rate of Rs 20 lakh per month from the last 10 months.
From this, we can also calculate that at the current burn rate, the business can survive for another 15 months without any further funding or cash infusion.
Startups depend on funding for their initial years of business and thus it is important, both for the business and the investors, to know at what point they might need further funding and to what extent.
Burn rate gives a quick snapshot of the cash balance and expense structure of the company, something not too relevant for an established profit making company, but very crucial for a new business or a company that has recently reached the breakeven stage.
Gross burn vs. Net burn
Gross burn rate is simply the capital or cash the business is spending each month during its daily operations. It includes all the expenses the business is incurring – salaries, maintenance, delivery charges, and rent etc. It is the outflow of cash to keep the business running.
Net burn rate is the amount of cash the business is losing per month, that is, the company’s monthly loss. Net burn rate nets any inflow the business might have.
Though, net burn rate is what is looked at first, but business should never ignore the gross burn rate. Profits fluctuate, drastically in case of startups, and this can lead to a sudden spike in burn rate leading to depletion of cash in hand.
Burn rates for valuations
Burn rate is an important metric considered while valuation of a company. However, it can change very quickly and can go in either direction. If month on month the business is able to generate more revenue than its expenses, then the burn rate will fall, giving the business more time to operate in the available cash and vice versa. That is, if expenses keep growing at a higher rate than revenues, then burn rate with shoot, giving the business less time with available cash.
Businesses tend to have a high burn rate in the initial days which fall as operations start to settle, thus, an analysis over a period of time cannot be done on a fixed burn rate and the variations have to be kept in account to arrive at an average.
A company needs to closely monitor and bring down its burn rate, especially while venturing out for funds. The first thing that an investor will look at is, if the projected revenues are higher than the burn rate. If the growth in burn rate is higher than expected revenues, the investment is considered risky.
A company can only bring down its burn rate through operational efficiency.
How to keep your burn rate in control
- Keep the sales graph growing – Till the business can manage a higher sales growth than the burn rate, the business is considered safe and a good investment.
- Control expenses – At this stage, controlling expenses can bring down the burn rate. Controlling every small expense helps, like watching electricity consumption, reducing unproductive staff, and wise use of stationery etc.
- Unit economies – Startups need to ramp up fast to reduce the fixed cost per unit. The faster the business grows, the quicker per unit fixed cost falls.
- High creditors, less debtors – This is one way of managing cash, trying to keep it with you as long as you can. Definitely not at the cost of upsetting the creditors, but business can try to delay its payments while ensuring timely receivables in cash.
- Reduce inventory days – Though it is safe to maintain some inventory, but it has its own cost. Reducing inventory days to least can help curb costs.
A company has to spend money to make money, however, it is very important to be very wise in spending. A company should focus on making the most out of the cash it has and be motivated to break even fast.
We have seen that in the new regime in Indian startup scenario, players who believed in “growth over profits” are coming back to burn rates and unit economies. Flipkart, with a burn rate of $80-100 million per month in the last quarter of 2015, is focusing to bring down its burn rate deviating from its complete focus on growth.
Snapdeal too had a burn rate of $20 million per month last year is aiming to bring down its burn rate by 40 percent this year. Food delivery players like Zomato and TinyOwl and grocery delivery players like Grofers and PepperTap shut operations in smaller cities as the business was not generating enough profits.