Business, Legal & Accounting Glossary
Burn rate measures the expenditures of a company or individual. Investors want this number to be smaller than the sales of the company.
e.g. if Manny’s Used Cars is spending 100k per month (that’s his burn rate) on employees, utilities, taxes and merchandise repurchases, he will want to do more than 100k in sales per month so he doesn’t run a negative cash flow.
Struggling companies often focus on reducing their burn rate (expenses) in order to return to positive cash flow. Typically staffing is the first victim in reducing burn rate. In more extreme cases cutting inventory or utility usage can be used, but both methods usually end up driving away more sales as well.
For investors burn rate is especially important to note in speculative startup companies like biotech stocks, where it may be several years before they generate any sales. The concept also extends to electronics/software start-ups of the Silicon Valley type. Start-ups often have an idea and an investor. Usually, they must achieve a series of milestones to qualify for additional funding. Burn rate provides an estimate of time to the next milestone.
In retirement planning, those who would retire on invested assets use the term burn rate to refer to the rate at which invested capital can be spent to pay living expenses. The calculations are complex and involve many variables, but most experts stipulate that you can plan to spend up to about 4% of your invested assets per year in retirement. That 4% is the burn rate.
The 4% burn rate allows your investments to grow so your retirement funds will last at least 30 years. It is a useful number for planning purposes, but most should consider the reciprocal (i.e., 25x or 25 years of living expenses) as the minimum needed to consider retiring on investment income.
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This glossary post was last updated: 4th August, 2021 | 0 Views.