Let’s face it, startups burn through funds quickly. The cash balance drops as your company continually spends on salaries, overheads, office rent, and more. In fact it’s easy to run out of funds if you don’t have a plan.
But how well you can handle cash (and how sustainably you spend it) could be one of the deciding factors for investors when you apply for venture capital.
What is a Startup Burn Rate?
The speed at which you spend money as a startup is known as the burn rate.
In fact, it’s something that an investor will heavily scrutinise before granting any investment capital. More importantly however, investors are keen to see exactly how your spending relates to the growth of your company over the same period of time.
So, whether you’ve just secured funding or you’re applying for the next round, you need to have a sustainable plan to spend the cash, and you need to know how to calculate your burn rate.
There’s just a few things to note before we get started:
- There is no ‘standard burn rate’ across the SaaS industry – it completely depends on your company.
- Burn rate should be tracked across time as you secure funding and spend money per month (or quarter).
- A “good” burn rate will let investors know that you can spend your money thoughtfully and wisely, rather than wasting cash grants.
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Calculate Burn Rate
Before we get down to the nitty gritty, it’s important to note that there are numerous methods for calculating burn rates. These apply in different contexts, including whether you want to consider the revenue or growth of the company or simply focus on expenses.
Gross Burn Rate
Gross burn rate refers solely to the expenses that apply to your company each month. The monthly burn rate (gross) could be due to operating expenses, and the other costs associated with being a startup.
The gross burn rate is calculated by only considering average monthly expenses.
Let’s take a look at an example. Imagine your company is spending the following:
- £2,000 on office rental
- £780 on software and program subscriptions
- £14,000 on payroll (salaries)
- £1,000 on utilities
- £220 on miscellaneous expenses
Knowing your burn rate is as easy as adding everything together, totalling £18,000.
As you can see, the revenue generated across this period is irrelevant.
Net Burn Rate
The net burn rate refers to the expenses applied, in the context of your monthly revenue.
The net burn rate is calculated with this formula: monthly revenue - monthly expenses.
For example, imagine your business spends the same as the above (£18,000), but has a monthly revenue of £40,000.
This means your company’s burn rate (net) sits at: (£40,000 - £18,000) = £22,000, which indicates you have a positive cash flow.
Cash Runway
Even if you have a negative net burn rate (i.e., your monthly expenses outweighs your monthly revenue), investors may still choose to award funding to your company. While there is a risk you will run out of cash, there is also a chance you may become profitable and grow with the right funding and planning.
Don’t worry, having a negative cash flow reflects the state of many small businesses and startups around the country. Therefore, investors would consider whether you have a financial runway and how long your current cash could last while you are losing money. Let us explain …
A cash runway is the amount of time your business will survive without access to any new funding.
Your small business could have enough cash in the bank for the next 10 months, for example, before generating new capital. Runway is dependent on two things:
- How much money you have in the bank.
- Your net burn rate (the speed at which you spend it).
The runway time formula: cash in the bank / burn rate.
You’ll need your burn rate calculation (let’s use £18,000 in this example) and total cash in the bank – we’ll say £54,000.
£54,000 / £18,000 = 3.
In this case, the financial runway number is three months, which shows how much time you’ll have at the current spending rate before running out of finance.
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Improve your Burn Rate
Luckily, the burn rate is impacted by a large range of factors. So if you have a high burn rate, there are a number of steps you can take. Most of these focus on reducing operating costs, which can be manipulated in order to make your spending more efficient, and make the money go further.
Reduced hires and increased redundancies
In the case of most startups, salaries are the single biggest cost each month. Think about it, you have senior leaders, human resources, marketing and sales teams – so much cash is allocated towards payroll!
It makes sense that hiring only when absolutely necessary is one of the most reliable ways to conserve your cash flow. But what about when you’ve already hired too many, too quickly? Unfortunately, enforced staff attrition may be one of your only options to try and plug the leak – especially when you are paying through the nose for top quality talent.
Employees in the SaaS industry can expect to work for a company for an average of just 2 years, so it’s not uncommon for staff to face redundancy. Plus, while it can be difficult to let good staff go, it should dispel any complacency among team members and make the workplace a more competitive (and hopefully, productive) environment.
Increased marketing testing
For many startups looking to conserve cash, thoughtful spending is one of the most important moves you can make. It means that before you commit to certain channels in marketing or sales, extensive testing is key.
For example, some startups in the SaaS industry benefit from content marketing. In fact, research has shown that potential buyers tend to consume 3-5 pieces of content before engaging in a sale. Alternatively, SaaS giant Salesforce doubled down on the SEO channel in order to appear in organic search results and get visible in front of their ideal clients.
Whatever marketing channels you eventually choose, remember to continue iterating, testing, and tweaking in order to build good ROI and ensure your funding is spent as efficiently as possible.
Increased flexibility
Increased flexibility is more-than-welcomed in the new working world of 2021. After most of us have experienced full time work-from-home during the pandemic, it’s now easier than ever to have more control over where, when, and how we work.
Increased flexibility can help companies cut down their expenses as well as boost the productivity of workers. It’s a win-win! Employees want to eliminate their commute times while employers want to reduce the costs associated with renting office spaces, equipment, and the utility bills that are attached.
Flexibility can look different depending on the specific conditions of your small business startup. For some, it means some workers step down from full to part-time hours. For others, it means cancelling the leased office space and having everybody work from home. Finding the right balance between investing in your employees and reducing expenditure will be the key in improving your burn rate.
We hope you enjoyed this article and found the value! If you did, leave a comment or share this with others who may find it useful!
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