Burn Rate is a venture capital term which describes the rate at which a company is exhausting its financial resources. In simple words it is the negative cash outflow that your company generates before it can generate a positive influx.
In ideal conditions burn rate is analyzed per month, however in crisis situations, the rate may be quoted in weeks or days.
Significance of Burn rate Metrics
An in-depth analysis of the burn rate allows investors to determine whether the company would be self-sustaining or it would need future financing.
A situation of crisis upon the company can be determined by making a comparison between the burn rate and the working capital of the company measured in the same time frame.
Cash Burn Consideration for Companies.
A high cash burn is a worry for the company, it’s akin to making a bet putting in all the stakes that you have. It is risky, because when all the cash burns out, the company yields the danger of going out of business. However, a slow burn rate might end up in lack of innovations and growth which is bad for business. A good management prefers to find the middle ground.
Normally, when companies work with a high burn rate or when the revenues (cash inflow) do not meet the forecasts, companies try to cut down on the high burn rate usually by reducing the staff members.
Startups usually have a high burn rate due to the constant contraction and expansion of businesses, so when passing their financial statements down, they add an additional term known as the cash zero date (a metric which indicates the date when the company would completely run out of cash).
Burn rate Determination
Burn rate of a company is determined by assessing the cash flow statement. A cash flow statement gives an idea about the firm’s cash position from one period to the next by accounting for the cash outflow from operations, and cash inflow from investment activities.
Financing burn rates
Many companies follow one or more of the following routes in order to finance their burn rate:
- Making cost reductions by making a cut down on the company staff.
- Selling off company assets.
- Raising external finances through the issuance of debt or equity.
If all else fails, companies undergo mergers.
It is not unusual for startups or mature companies to have a high burn rate. However, a high burn rate for an extensive period of time is an alarming sign. Unprofitable companies that hold high investor enthusiasm can finance the cash burn through the issuance of new shares. Hence, shareholders cover the cost of the company. However a lack of investor exuberance requires companies to live off of their bank balances.