Using Numbers to Make Money —
What is your burn rate (aka total expenses)?
The ‘Using Numbers to Make Money’ are a series of blog posts to help entrepreneur’s understand key business metrics in plain English and use them to make money.
Burn rate
Also-Known-As: Costs, on-going expenses, liabilities (current and long-term)
Common question from investors: What is your burn rate?
In plain English:
How much money do you need (or are you using) to run your business? (commonly stated as cash spent per month)
Why is it important?
Calculating your expenses is necessary to complete your income statement (one of the 4 major financial statements) and create a financial model. It is also used in presentations, applications, and business plans. Most importantly, it is used to calculate how much money the business needs to function. Cash is the blood of a company. Leaders of the company need to know how much is coming in and going out to keep the company alive.
Example:
Let’s continue to imagine that a start-up team is coming out with the MouthScan, the next generation magic mouth scanner that cleans your teeth instantly.
Our team has two founders, one focused on hardware development and another on sales and marketing each requiring $4,000 per month. They are also members of a makers space ($50 per person per month) and have website support costing $50 per month). We estimate travel costs are about $500 per month and hardware development costs are around $500 per month.
Sample Calculations (all calculations are per month):
$4,000 — Founders pay (X 2 people)
$50 — Maker’s space (X 2 people)
$50 — Hosting costs
$500 — Travel costs
$500 — Hardware development
$9150 = estimated burn rate
These on-going costs (or expenses) are referred to as the burn rate, because it is the rate at which your company consumes (or ‘burns’ through) cash. Typical categories for expenses used to create a more extensive and detailed estimate of the teams ‘burn rate’ are your engineering expenses, your marketing expenses, your sales expenses, and your general administration expenses. Each area includes staff, software, hardware, and operational costs. It is important to understand how your ‘burn rate’ will change over time as you grow and scale.
The burn rate does not include the one time capital costs that may be needed for funding milestones such as getting a first working prototype of the device from a manufacturer.
On-going expenses fit into the category of current liabilities. Current liabilities are costs you have to pay within the next year. Long-term liabilities are costs that are due in a year or more.
Where is this metric used?
It is found in business plans and for presentations to investors, incubators, and accelerators. It is one of the basics that the business lead on the team needs to be able to answer (and explain the details of) in a heart beat.
Like any early stage start-up, the burn rate will change over time, but the goal initially is to keep it as low as possible starting out.
Cash is the lifeblood. Knowing how much your team has and managing how fast you are burning through that cash can buy you the time you need to get the business moving. Knowing your expenses also informs how you will need to structure your business model and is needed to calculated your profit, which is in the next post.
