Whether your business is just starting up or gearing up for a round of venture capital, your ‘burn rate’ is an important number to understand and manage. It can help you determine if you are keeping enough working capital on hand and can help you make a plan to compensate for any losses in profit.
Burn Rate Definition
A burn rate is a rate at which you spend your financial reserves. There are two types of burn rates to pay attention to: gross and net. The gross burn rate is the total amount of capital being spent monthly. This will include things like office or retail space rental fees, employee salary overhead, inventory costs and marketing.
The net burn rate, on the other hand, is your total outgoing capital minus your monthly profit. For example, if your monthly gross burn rate is $50,000, but your firm brings in $20,000 a month in profits from your product or service, the net burn rate would $30,000.
What is the Right Burn Rate?
So how do you know if your burn rate is too high or too low? It might seem logical to keep as low a burn rate as possible. Fewer expenses equals higher reserves and working capital, right? That theory does not take into account opportunities for growth that a higher burn rate can sometimes afford. A temporary increase in your burn rate can bring in higher profits if the increased expenses are aimed at maintaining your product lead or capturing markets and consumers before your competitors. This might translate into things like investing in product engineering, opening new locations and pushing out new marketing.
And of course, there are expenses that are less effective as part of your small business burn rate. Office space and staff overhead are some costs that should be kept to a minimum, especially for companies in the startup and early phases.
By keeping an eye on both your gross and net burn rates, you can monitor your company’s profitability and determine your plans for possible dips in revenue. Maintaining a reasonable burn rate will aid you in growing your business and improving your bottom line.