If you are managing your own business, you want to know how much cash you are spending or “burning”. That figure, how much money you spend each period, is your cash burn rate. Every entrepreneur should know this number.
Cash Burn Rate Definition
The Cash Burn Rate is the amount of money that is being used up by a business in a given period of time. You can compare this to a car engine. How much fuel does the engine use or burn to drive one kilometer? The cash burn rate tells you how much cash your business is burning to continue or drive for one month (or any other period over which you would like to measure it). The total number of months your business can continue without running out of money is your cash runway.
Cash Burn Rate Calculation
The Gross Cash Burn Rate only takes into account the cash outflow of your business. It ignores the cash inflow your business generates (from revenue and other sources of cash). You can calculate the gross cash burn rate by adding all cash payments over a given period of time (usually one month).
Monthly Gross Cash Burn Rate = the sum of all outgoing cash payments during a month, the total cash that is spent each month.
The Net Cash Burn Rate starts from all the cash flowing into your business
Monthly Net Cash Burn Rate = monthly cash inflow – monthly cash outflow = the sum of all the cash flowing into the business – the sum of all the cash flowing out of the business, on average during a month (usually calculated as the average over the last 6 or 12 months).
For example: at the start of the year, you had 150k on your bank account. Now, by the end of June, your bank account shows a balance of 90k. As a result, the monthly net cash burn of your business over the last six months is 10k.
Cash Runway Definition
The Cash Runway of your business tells you how much longer you can keep running the business without running out of cash.
Measuring your cash runway is important. Especially when your current cash outflow is higher than your cash inflow. In that case, you are burning cash every month. Then you need to get a view on how much longer this can continue.
In the example above, the monthly net cash burn rate was 10k. With a current bank balance of 90k, the cash runway of the business is 9 months. In other words, if no additional money comes in and the monthly cash burn rate stays the same, the business would run out of cash after 9 months.