When it comes to running a startup or growing a small business, the net burn rate metric is one to monitor closely.
Your net burn rate measures your company’s cash outflow compared to its revenue. It differs from gross burn rate, which is only a measure of expenses without considering income.
In this article, we’ll look at the meaning of net burn rate and how to calculate it. Next, we’ll explain its importance and how to benchmark it.
We’ll also provide seven powerful tips for reducing your net burn rate, explore some related metrics, and answer your frequent queries (including the gross burn comparison).
This Article Contains
- What Is Net Burn Rate?
- How to Calculate Net Burn Rate
- What Is a Good Net Burn Rate?
- Why Is Net Burn Rate Important?
- 7 Tips to Decrease Your Net Burn Rate
- 5 Related Metrics to Track
- 4 Burning Questions about Burn Rate
Let’s dive in.
What Is Net Burn Rate?
Simply put, net burn rate (or net cash burn rate) is the rate at which your company loses money. If your net burn rate is a positive number, it means your operating costs are higher than your revenue.
The relationship with profitability works like this:
A positive net burn rate means you have a negative cash flow.
Conversely, a negative net burn rate means a positive cash flow.
It’s like golf: the lower your score, the better you’re doing!
Most businesses calculate net burn on a monthly basis to understand when they’ll exhaust their cash balance.
So, how do you determine your net burn?
How to Calculate Net Burn Rate
Before calculating your burn rate, you should calculate your net burn in cash.
You can do so with this formula:
Net Burn = monthly revenue – total cash outflow
You can also calculate net burn as:
Net Burn = End of month cash – Start of month cash
Now that you know your net burn, you can follow this burn rate calculation formula:
Net burn rate =Net burn / Current cash balance * 100
Net Burn Rate Calculation Example
Say your company spends $50,000/month, generates $30,000/month in revenue, and has $1,000,000 cash reserves.
This means your net burn is $20,000 and net burn rate = 20,000/1,000,000*100 = 2%.
So, for each month that passes at this net burn rate, you’re losing 2% of your remaining cash. Although this situation isn’t yet dire, you’ll run out of cash eventually unless you take steps to increase revenue and lower your expenses.
Who Should Calculate Net Burn Rate
Any company – SaaS or otherwise – can and should calculate their net burn rate. There’s always room to improve your expenditures even if your company is profitable.
However, in the SaaS industry, this metric is most crucial for early-stage SaaS startups that aren’t yet profitable. That’s because it’s vital to monitor your losses in order to make informed decisions around optimizing revenue and expenses.
When Should You Calculate Net Burn Rate?
SaaS companies should calculate their net burn rate on a regular basis, typically monthly and quarterly.
This is important because it helps SaaS companies identify potential cash flow issues and take action to address them before they worsen. Additionally, SaaS companies need to be able to project how long their cash reserves will last so they can plan accordingly.
So, what should you aim for regarding burn rate?
What Is a Good Net Burn Rate?
There’s no standard benchmark for net burn rate – you should evaluate it in terms of your other metrics and your cash runway.
However, it’s recommended for businesses to have a cash reserve that can cover monthly expenses for six to 12 months. So, a good burn rate should facilitate this goal.
But what are the implications of the net burn rate metric?
Why Is Net Burn Rate Important?
Here are four reasons to track and optimize your net burn rate:
1. Indicates Potential Financial Distress
This is a no-brainer: A negative cash flow where expense outweighs revenue is unsustainable.
Note: It’s common for a startup or small business to burn cash before achieving a positive cash flow. However, if you see a high burn rate for a long time, start planning a solution.
2. Crucial Metric for Investors
Your net burn rate is a vital metric to any potential investor or venture capitalist because it lets them know:
- Whether you’re spending resources efficiently.
- When you’ll draw a positive net income.
- When you’ll need more funding.
This helps investors assess whether your business is a good investment opportunity.
3. Helps Assess Your Spending Habits
Sure, you have to spend money to make money.
A very low burn rate could indicate that you’re not properly investing in your company’s growth.
However, you must also spend your venture capital wisely to unlock long-term growth.
In most cases, there are unnecessary monthly expenses you could cut out or restrategize to reduce costs and minimize cash burn.
4. Helps you Set Revenue Targets
Knowing your rate of monetary loss tells you what it will take to become profitable.
Net burn rate shows you how much more revenue you’ll have to generate, which can guide your revenue strategy.
Now let’s explore how to minimize cash burn.
7 Tips to Decrease Your Net Burn Rate
Below are the seven best strategies for stabilizing your net burn rate if it’s too high:
1. Reduce Operating Costs
New businesses often worry that they’ll have to resort to layoffs and pay cuts to reduce their startup burn rate.
However, there are many other ways to reduce operating expenses, such as:
- Reducing office space (e.g., consolidating workspaces, implementing remote work).
- Using energy efficiently (e.g., turning off appliances when not in use).
- Outsourcing non-core functions like customer support, accounting, and marketing.
- Promoting a positive work culture to improve employee retention, as hiring a new employee is almost always more expensive than retaining one.
2. Rethink Marketing
There are many ways to spread the word about your company without breaking the bank on costly paid advertising.
Examples to add to your marketing strategy include:
- Gaining organic traffic from search engine optimization (Check out Startup Voyager!)
- Incentivizing referrals from existing customers.
- Starting an email marketing campaign.
- Using non-paid social media marketing.
- Adopting a product-led approach.
3. Obtain Investment for Growth
It’s common for SaaS startups to have a bumpy start.
However, if you can secure funding for growth, you can unlock economies of scale.
What are economies of scale?
It refers to cost advantages accessible by scaling up your operations. For example, your net software development costs decrease as your user base grows. It’s the same amount of work but generates more revenue.
To secure funding, you can carefully calculate growth forecasts and economies of scale that map the future growth of your company. This can show investors that your company can still be a profitable investment.
Once you gain funding to access economies of scale, your net cash burn rate should typically decrease.
4. Track Expenses by Category
To assess which areas are most costly, track your cash outflow in expense categories such as:
- Property costs (e.g., rent and utilities)
- Supplies and equipment
Once you do, tackle how you can reduce your spending in the biggest money-draining categories.
5. Optimize Your CAC
By identifying and focusing on the most effective customer acquisition channels, you can maximize your marketing ROI (return on investment).
Track your conversion and retention metrics for leads from different channels. You can then invest more time and resources into channels that produce high-quality leads.
When you do so, you get more revenue for the same investment. Your customer acquisition cost (CAC) drops, and you can stretch your available funds further.
6. Focus on Products that Sell
Sometimes it’s necessary to delay your ambitions of selling a variety of products simultaneously. Supporting an underperforming product can be a costly operating expense.
It can be more cost-effective to focus your resources only on products that sell well and generate a lot of revenue.
7. Stick to the Essentials
Similarly, if you’re burning cash quickly, you may need to refocus your resources on the most essential and efficient ways of delivering what’s necessary.
For example, if you’re developing a SaaS product, you can take steps like:
- Focusing on core features before developing additional ones.
- Targeting fewer customer segments.
- Simplifying customer support by implementing self-service options.
Now, here’s the thing:
You should always consider net burn rate relative to other vital growth metrics.
Let’s take a look at a few.
5 Related Metrics to Track
Here are the top five metrics to consider alongside net burn rate:
- Customer acquisition cost (CAC): The total amount it costs your company to acquire a new customer.
- Customer lifetime value (CLV): The total value that a customer will generate for a business over the entire relationship.
- Customer churn: The percentage of customers who stop using your products or services within a given period.
- Revenue Churn: The amount of recurring revenue you lose in a period due to customer churn or a decreased ARPU (average revenue per customer).
- Monthly recurring revenue (MRR): The total amount of predictable, recurring monthly revenue generated by your subscription-based products or services.
Tracking these SaaS metrics together is crucial for comprehensively analyzing and understanding your revenue.
Next, we’ll answer some questions you may have about net cash burn rate.
4 Burning Questions about Burn Rate
Here are four common queries about net burn rate, answered:
1. What Is the Difference Between Gross and Net Burn Rate?
Both gross burn rate and net burn consider cash spend and are usually calculated monthly. However, there are some major differences.
- Gross burn rate measures a business’s operating expenses without factoring cash inflow into account. In other words, it’s the total amount of money you’re spending.
To perform a gross burn rate calculation, divide your total monthly expenses by your total available cash.
- Net burn rate, on the other hand, tells you how much cash you’ve actually lost, after accounting for the revenue (cash inflow) you’ve gained in the same period.
For example, if you have $100,000 cash on hand and you’ve spent $20,000 on marketing in the last month, your gross burn rate was 20%. But if you’ve made $15,000 in revenue at the same time, your net burn is only $5,000, meaning your net cash burn rate is just 5%.
2. Is Burn Rate the Same as Expenses?
In the case of gross burn, yes, it’s the same as monthly operating expenses.
Gross burn doesn’t consider revenue.
However, net burn measures both, your cash outflow and your revenue. So, it’s closely related to net income (revenue after expenses) on your cash flow statement. If your net burn rate is positive, your net income will be negative.
3. What Is Cash Runway?
Cash runway refers to how long your available cash will last, given your net burn. It’s crucial for understanding your business’s profitability.
You can calculate your cash runway using the following formula:
Cash runway = Total cash / Net burn
For example, say your company has a current cash balance of $1,000,000. You bring in $30,000/month and have an operating expense total of $50,000/month.
This means you have a net burn of $20,000/month. If you continue at the same monthly burn rate, your cash balance will run out in 50 months – your cash runway.
4. Is a Higher Burn Rate Always Bad for Startups?
It’s logical to think that spending more money than you earn is always a no-no. However, a good burn rate isn’t always a low burn rate.
Many businesses burn cash before becoming profitable. That’s why you should have a cash reserve and calculate your cash runway.
Moreover, a higher burn rate can be beneficial when pitching a venture capitalist or investor. They may question why you need a larger sum when your gross and net burn rates are still relatively low.
But when an investor looks closely at your cash flow statement and sees that you’re spending money effectively and are ready to scale your funding, they may be more willing to invest.
What’s important is that you take the necessary steps to optimize your cash flow and spending strategically. You shouldn’t let your net burn rate exceed the recommended six to 12 month runway, or maintain a high burn rate for extended periods.
To Burn or Not to Burn
Maintaining a healthy net burn rate is essential for startups and companies seeking long-term success. It demonstrates your ability to manage your finances effectively and avoid cash flow problems.
While a high net burn rate can be a strategic choice, it can also be a warning sign that you’re struggling to offset your expenses.
To decrease your monthly burn rate, you can focus on reducing monthly operating expenses, improving revenue streams, and optimizing your CAC. Additionally, you should track your growth metrics and forecasts to secure adequate venture capital funding.
Do you need a hand attracting customers in a way that minimizes cash burn?
Sounds like you could use Startup Voyager’s assistance.
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Reach out to Startup Voyager today to see how our team can help you improve traffic and conversions without the paid advertising hassles.