If your company is a start-up, or if you are concerned about how long you can survive without seeking more financing, one financial metric you need to be able to calculate is the burn rate. Simply put, the burn rate is how fast you "burn" through cash in your business. All companies are concerned with the burn rate.
How do you Calculate the Burn Rate?
The "interval measure" is used to calculate the burn rate. The formula used is:
Current Assets/Average daily operating costs = Burn Rate
Current Assets is taken from the firm's balance sheet. Average daily operating costs are taken from the income statement and cash flow statement. You usually do not include depreciation in this figure but you do use interest expense.
What is the Burn Rate?
XYZ, Inc. is a start-up technology company located in Silicon Valley. It has just been granted venture capital funding for a software product it is developing. The terms of the venture capital funding gives XYZ a certain number of years to breakeven or become profitable. XYZ wants to burn through the cash from the venture capital firm as slowly as possible. After that cash is gone, it will need to apply for more venture capital funding, loans, or do an initial public offering to stay afloat.
Why Does the Burn Rate Matter?
Investors look at a start-up companies burn rate and measure it against future revenues of the company to decide if the company is a worthwhile investment. If the burn rate is greater than forecast or if the company's revenues are not growing as rapidly as they are forecast to grow, then investors may think the company is not a good investment. It may be too risky.