Accounting: Cash Burn Rate
A common business term that is often heard but not always understood is Cash Burn Rate, or simply, Burn Rate. Although it is most often used in relation to start-up organizations, it can also be useful for revenue-generating firms in cash planning.
What it means: A company’s Cash Burn Rate is the average outflow of money each month or the rate at which a company is using their available cash. It is different from ‘total expenses’ in that it includes not only money spent on operating expenses but also expenditures for capital equipment, prepayments (like insurance), and deposits (on office space or equipment leases.)
If a company has sources of cash inflow (Sales, grants, loans, etc.), they can be netted against the outflow to assess the Net Burn Rate, but if these sources are inconsistent or unreliable, they should not be included in the Burn Rate calculation.
Why it matters: The Cash Burn Rate is critical for visibility of cash consumption. This is particularly important in the absence of revenues since operations will cease when the cash is gone. It can, however, also be an aid to management to stem spending in order to reduce the Burn Rate and, therefore, extend the life of existing cash on hand.
How to use it: The Cash Burn Rate is used to calculate when cash reserves will be depleted, or, better yet, when to begin the search for an infusion of funds. For example, a developing business with $1,000,000 in the bank and a Burn Rate of $250,000/month will be out of funds in 4 months. If a funding event requires 60 days to close, then identification and courting new investors is an urgent task for management.
The actual Burn Rate is nearly always required by prospective investors who want to know how long their funds will keep the company operational. From this, they can gauge whether the company will have advanced far enough for subsequent rounds to command a higher price.