Burn rate is one of those important metrics that shareholders, CEOs, investors or others involved could use to define how well a company is doing. Here is what you need to know about the burn rate and some ideas on how you can use it in your business reporting.
What does burn rate mean?
Investopedia describes burn rate as the rate at which a new company is spending its venture capital so that to finance its operations before actually getting money from cash flow. According to Investopedia, “the burn rate is usually quoted in terms of cash spent per month.” Burn Rate measures how quickly the company’s cash holdings are decreasing.
If a company has $300,000 in initial funds and its burn rate is $30,000 per month, it will be out of cash in 10 months. The company can reduce its burn rate or raise money to avoid “zero cash day.”
According to Baremetrics, companies that are profitable have a negative net burn, because they are getting more cash than spending. If a company wants to find out when it will run out of money, measuring burn rate is an option.
Many start-ups have struggled with balancing burn rate. It is often difficult for a start-up to generate a positive net income. Wharton University of Pennsylvania says that some startups tend to spend a lot of money to “attract quality employees, get economies of scale early and grab market share from the incumbent.” Overspending money can lead to a high burn rate and a waste of resources. Because investors sometimes make a decision based on the company’s burn rate, it is important to keep the balanced rate of spending.
How to understand a burn rate
Get yourself familiar with terminology. Here is some vocabulary that may be useful for a starting point while reporting on the burn rate.
Gross Burn Rate – Baremetrics explains the term as the total amount of cash that the company spends each month.
Net Burn Rate – it is a difference between cash out and cash in. In other words – the money company loses each month.
IPO – initial public offering or in other words “going public.” It means to offer shares of stocks to the public. If the company is going public, it requires capital for further expansion, therefore it is successful.
Zero cash day – the day a company is completely out of money. According to EquityNet a very rough calculation would be to divide cash on a particular day by the average monthly burn rate and adjust for number of days. Zero cash day depends on how quickly a company burns money.
Free cash flow – the cash flow generated after cash outflows so that a company could finance its operations and maintain its capital assets. Free cash flow measures profitability.
Run rate – refers to the financial performance of the company based on its current financial state.
Reporting on a company’s burn rate
Look through the company’s financial documents. A financial statement and 10-K filings can be a good place to start as they give information about the company’s sales, revenues, net incomes and other indicators. Business journalists can find some companies 10-K filings on U.S. Securities and Exchange commision website.
Local business reporters should keep an eye on what others are reporting nationally. Bloomberg reported that a great deal of new companies are burning money and Tesla Inc. is one of them. MarketWatch reported earlier this year that Netflix was burning money and it’s business model was not strong enough. Los Angeles Times wrote an article about Uber and it’s preparation for initial public offering.
Experienced business analysts can also provide an insight into a company’s business model and whether it’s working or not, how the company’s long-term trend looks like. They are often used as sources by trustworthy media organizations.