Burn rate: Definition, importance and how to calculate it

Business owners—especially new business owners—need to balance their current cash reserves with their overhead costs, growth goals, fundraising and more. One helpful tool for understanding and managing these priorities is burn rate: a metric that shows how much money your business spends per month.

Managing burn rate is key for business owners looking to attract investors, monitor spending and plan for the future. Keep reading to learn more about burn rate, why it matters and how to calculate it for your business.

What you’ll learn:

• Burn rate is a metric that represents how much money your business is spending each month—whether before accounting for revenue (gross burn rate) or after accounting for revenue (net burn rate). 

• Investors often look at a company’s burn rate when deciding whether to invest, because it helps them assess how well the business is using its cash reserves and how long those reserves are likely to last.

• Business owners can calculate their burn rate with a simple formula, which can help identify problem areas in their business model and support conversations with potential investors.

• To reduce burn rate and extend how long their cash will last, business owners can focus on increasing their revenue, retaining customers, reducing spending and optimizing operations.

Burn rate measures how much money your business needs to cover its expenses over a given period of time, usually a month. A business can use its burn rate to understand how quickly it’s spending its cash reserves. While burn rate is most often used by startups that haven’t yet become cash-flow positive, any business can use burn rate as a guiding metric.

There are two main types of burn rate that business owners may find useful, each offering insight into different aspects of a company’s financial health:

• Gross burn rate refers to the total operating costs a business incurs per month, including rent, salaries, utilities and marketing costs. It can help businesses identify their main cost drivers and potential places to cut back.

• Net burn rate refers to how much money a company is losing per month after factoring in expenses and revenue. It can help businesses understand how long their capital will last at their current rate of spending.

For instance, a business that spends $50,000 per month on operating costs has a gross burn rate of $50,000. If that same business earns $35,000 in monthly revenue, subtracting revenue from expenses results in a net burn rate of $15,000.

Cash runway is the number of months your business’s capital will last at its current burn rate. A high burn rate indicates you’re spending your cash more quickly, which means your cash runway is shorter. Conversely, a low burn rate results in a longer cash runway, meaning your capital will last longer.

Burn rate is important because it helps show how well a business—especially a new business—is managing its capital. A low burn rate, along with a longer cash runway, indicates that a business can make its capital last. This can be encouraging for potential investors, who typically want to see a clear path to returns. In many cases, a lower burn rate can increase your chances of becoming profitable in the long run.

For established companies, burn rate can still help measure financial performance, especially during slower seasons. It can reveal areas where a business may be spending beyond its means and help business owners plan ahead and make strategic decisions. A lower burn rate often indicates that a business is carefully managing its money.

If your company has a higher burn rate, however, that could mean you’re running out of cash sooner rather than later. In this case, burn rate can signal that it may be time to find a way to increase revenue or cut back on how much your company spends.

Both gross and net burn rate are fairly simple to calculate. Here’s how to calculate each, starting with gross burn rate. 

The formula for gross burn rate is:

Gross burn rate = Monthly operating costs

For example, a business may have the following monthly operating costs:

• $10,000 in cost of goods sold (COGS)

• $20,000 in rent

• $30,000 in wages

• $40,000 in other overhead costs

To calculate the gross burn rate, just add up all the operating expenses:

$10,000 + $20,000 + $30,000 + $40,000 = $100,000 gross burn rate

This means the business is spending $100,000 per month, regardless of how much revenue it’s bringing in.

The formula for calculating net burn rate is:

Monthly operating costs − Monthly revenue = Net burn rate

If the same business earns $45,000 per month in revenue, the net burn rate would be:

$100,000 − $45,000 = $55,000 net burn rate

This means that while the business spends $100,00 per month, it’s losing $55,000 after accounting for revenue. And since revenue can fluctuate month to month, a single month’s net burn rate may not reflect reliable spending trends for the whole year.

You can use your net burn rate to calculate your cash runway with the following formula:

Current cash balance ÷ Net burn rate = Cash runway

Using the same example as above, let’s say the company is operating with a $55,000 net burn rate and has $660,000 in cash on hand. Its cash runway would be:

$660,000 ÷ $55,000 = 12 months of cash runway

This means the business can sustain itself for one year at its current net burn rate.

A “good” burn rate varies based on many factors. For instance, brick-and-mortar businesses may require more overhead than digital businesses, which can naturally produce higher burn rates. But if your expenses are low because you aren’t investing in growth, you may have a low burn rate while your business stagnates.

One common rule for startups is to have enough cash reserves to last at least 12 months. Beyond that, a good burn rate comes down to evaluating your business model, growth goals and funding strategy. Your definition of a good burn rate may also change as your business grows and reaches new milestones.

When evaluating your burn rate, here are a few red flags to keep an eye on:

• Spending money quickly, without seeing a rise in revenue

• Relying on investors to prevent cash shortfalls

• Spending habits remaining constant, regardless of changing market conditions

Investors want to see that you can leverage their capital efficiently. If your business raises any of these red flags, you may need to look for ways to reduce your burn rate.

A number of strategies can help reduce your burn rate:

• Increase revenue. Even a slight price increase can have a cumulative effect on your revenue. The more revenue you generate, the more it can help offset losses, lower your net burn rate and extend your cash runway.

• Focus on customer retention. Another way to increase revenue is to invest in retaining existing customers. If your customer turnover rate is high, it will likely be necessary to frequently acquire new customers. The more effectively you retain existing customers, the stronger your bottom line can become.

• Decrease spending. Your business operations may include some expenses you can reduce. Whether that’s adopting a more targeted marketing strategy or cutting back on monthly subscriptions, your gross burn rate can help identify potential areas to cut costs in your budget. Lower spending reduces burn rate and extends your cash runway.

• Optimize operations. Another way to cut back on monthly costs is by streamlining your operations. Look for places to incorporate automation or simplify your supply chain to bring down your overhead. Strategic vendor management is often a great place to start.

These strategies can help make your business more attractive to investors and more profitable and sustainable in the long run.

Understanding burn rate is important for effectively managing your business’s cash reserves. You can use this knowledge to make strategic shifts to your business model, prepare for investor conversations and plan ahead.

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