3 Important Burn Rate Considerations for Every Business

Burn rate is something every entrepreneur needs to be
familiar with, whether you’re intending to go after
venture capital or not. While burn rates are most closely
associated with valuations and capital raising for
startups, there are important aspects of your business’s
bottom line with or without VC money.
You may immediately be tempted to think that the
obvious advice is spend less, have a smaller burn rate
and preserve your capital for operations as long as
possible, however that’s not always the case.
Related: How Much Money Should Your Startup Be
Burning Through?
Here are three important burn rate considerations for
every entrepreneur to know and understand. What makes
sense for your business will be unique to your needs, but
a basic comprehension will give you a leg up in
operating capital.
1. Understand net vs. gross
The difference between the terms net and gross is
important for your accounting and for your burn rate
comprehension.
An entrepreneur’s gross burn rate means the total
amount of capital you’re spending monthly. That’s going
to include all your outgoing cash flow for all your
operations to keep the business running. Your net burn
rate on the other hand is your monthly loss.
What’s the difference? The best way to explain it is with
some easy rounded numbers. Let’s say your business in
spending $50,000 in operating expenses, but you’re
making $25,000 in profit each month from monthly
subscriptions for your product or service. Your monthly
gross burn rate is $50,000 because regardless of
business revenue, that’s how much you’re spending.
However, your net monthly burn rate would only be
$25,000, since you’re spending $50,000 but bringing in
$25,000.
Most VCs and entrepreneurs are going to pay attention to
that net $25,000 burn rate number, but keep in mind
your overhead because if profits drop, you will either
have a large increase in net burn rate, depleting your
cash on hand, or you’ll have to decrease your gross burn
rate to compensate for the profit loss to keep your net
burn rate the same.
Know the difference between these two key figures so
you can keep a healthy perspective on your overall
operational bottom line.
Related: Grow Your Business Without Drowning in Debt
2. Burn vs. opportunity
It’s easy to think that you want to reduce your burn rate
to preserve your operating capital, but there are forgone
opportunity costs to consider when factoring your burn
rate. Often, a greater output in capital can correlate to a
drastic leap up the learning curve as you operate and
scale your business. You’ll have to carefully consider
what you’re spending money on to decide whether it’s
more prudent to save the cash, or scale your growth
faster.
If a huge leap in growth comes at the expense of a
reasonable increase in gross monthly burn, it just might
be worth it to increase your spending. Consider the cost
of slower growth, missed opportunities and the affects
those could have on your business in the long-term, not
just the short-term effects of increasing your spend.
3. Not all burn is create equally
Related to point number two, not all burn rate spending
is bad or good. As the creator of your business the
tough decisions of what to spend money on are
ultimately up to you decipher. Just remember that not all
kinds of burn are created equal.
I’ve long been an advocate of keeping staff and office
space overhead low to leverage monthly capital into
systems and operating structure that can scale faster. If
you had $10,000 a month available for gross burn, you
could choose to spend $1,500 of that on an office lease,
$3,500 on staff and be left with 50 percent of your
budget to actually grow and scale the business.
I have always preferred to try to keep outsourced labor
and contractors, which tend to offer project-specific
budget spending vs. ongoing daily salary and try to keep
office space to a minimal, at least when starting out. It’s
up to you to decide which type of expenses are going to
move the needle the most for your business, but
consider the implications of large overhead spends such
as leases and staff and what that operating capital might
be able to do for your business overall before
committing to that gross monthly burn.