Business, Legal & Accounting Glossary
Burn rate is the speed at which a company spends shareholder capital, depleting its cash reserves.
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.
Negative cash flow
Positive cash flow
Mergers and Acquisitions
The burn rate is the rate at which a startup company spends its existing funds on overhead expenses before it generates a positive cash flow. In general, it is calculated as the amount of money spent each month. If the company is unable to generate revenue after a certain period of time, it must reduce its burn rate, which may imply lowering its monthly operating expenses.
The amount of money that a company loses each month due to operating expenses is also known as the burn rate. Burn rates are classified into two types: gross burn rate and net burn rate. The gross burn rate is the total amount of money that a company spends each month, whereas the net burn rate is the difference between the amount of money spent and the amount of money earned during the month. For instance, if a company spends $1,000 and earns $600, its gross burn rate is $1,000 and its net burn rate is $400.
Before investing in a company, many investors carefully examine the net burn rate. For example, if a company has a cash reserve of $2,000,000 and a burn rate of $100,000, it has enough cash to sustain operations for the next 20 months, assuming the burn rate does not increase. On the other hand, if a company’s burn rate is $500,000, it will only have enough money for four months. Existing investors should make plans to bring in more investments based on the number of months a company has a sustainable burn rate.
This burn rate can also be used to determine how much money should be raised in each round of funding. For example, if a company only spends $50,000 per month, there is no need to raise $10,000,000 in the initial round of funding. In this sense, the burn rate aids in determining the amount of money that a company requires at any given time.
In the event of an M&A, the acquirer should carefully examine the burn rate to determine how much liability exists and how much funding is required. A company seeking venture capital funding will typically raise enough cash to cover an 18-month burn rate.
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This glossary post was last updated: 26th January, 2022 | 0 Views.