Imagine a promising tech startup that recently secured Rp500.000.000 in funding. The founders are excited to “burn money” on activities such as scaling operations, hiring top talent, investing in marketing and product development, etc. However, within 10 months, the company faces a grim reality: its cash reserves are almost depleted, and profitability is still out of reach. What went wrong? The answer lies in its burn rate.Burn rate is a crucial metric for determining how long a company can sustain its operations, depending on its current cash reserves. Let’s learn more about burn rate's meaning in business and how to determine it.

What is The Burn Rate?

Burn rate is a financial metric that indicates the speed at which a company consumes its cash reserves, typically monthly. This metric is commonly used to assess how long a company can continue operating before it becomes profitable or needs additional funding. Many entrepreneurs may wonder what constitutes a good burn rate. While this varies by industry and business stage of development, a lower burn rate is typically considered favorable, as it indicates efficient use of funds. Conducting a burn rate analysis allows entrepreneurs to assess the company's financial health over a specific period.

Why is Burn Rate Important For Business?

Here are several reasons why burn rate is important for business:

Financial Health Indicator

A high rate often indicates potential financial troubles, showing that the company burns too much cash if spending is not controlled. Conversely, a low rate might suggest inefficiencies or missed growth opportunities, as the company may not invest enough. Monitoring this metric is essential to maintain a balance between spending and growth.

Cash Flow Management

Burn rate measures how quickly a company is spending its cash reserves. With this, the company can forecast when it may run out of funds and make informed decisions about future additional funding or cost-cutting measures. This is important for startups that often operate at a loss in the early stage while trying to establish themselves in the market.

Strategic Decision Making

Analyzing the burn rate can help make strategic business decisions such as scaling operations, hiring new staff, or launching new products. The company can align its financial strategies with long-term business goals by assessing this financial metric alongside revenue growth and business objectives. The company can also adjust operational strategies based on current financial conditions.

How To Calculate Burn Rate?

Both gross and net burn rate have different purposes and ways of being calculated. 

Gross Burn Rate (GBR)

The GBR represents the company's operating expenses. It is calculated by totaling all the operational expenses, such as rent, salaries, and other overheads every month. Here is the formula for GBR:

Gross Burn Rate (GBR) = Total Monthly Cash Expenses

An example of the GBR is when Company A has monthly expenses of about Rp80.000.000, which consist of salaries, rent, utilities, product development, etc. This means the GBR is Rp80.000.000.

Net Burn Rate (NBR)

The NBR takes into account both expenses and revenue. It shows how much money a company loses monthly after accounting for income. The formula is:

Net Burn Rate (NBR) =  Total Monthly Cash Expenses – Total Monthly Revenues

An example of the NBR is when company A, with monthly expenses amounting to Rp80.000.000, generates Rp10.000.000, then the NBR is Rp70.000.000.

Cash Runway

After determining the net burn rate, the next part calculates the cash runway, which measures how long the company can operate before running out of cash. The formula is:

Cash Runway = Current Cash Reserves: Net Burn Rate

For example, Company A has cash reserves of around Rp210.000.000 and a net burn rate of around Rp70.000.000. It can sustain operations for three months without additional income or investment.

What Are The Differences Between Burn Rate vs Run Rate?

Burn rate refers to the pace at which the company consumes its cash reserves, typically calculated monthly. This rate is crucial to understanding how long the company can operate before it needs to generate positive cash flow or secure additional funding. On the other hand, run rate is a metric to estimate future revenue based on current performance, extrapolating the annual earnings from the company’s current revenue stream. It predicts how much revenue the company can generate over a specified period (typically annually). The run rate helps businesses forecast their future revenue, assuming that current conditions remain consistent providing insights into potential growth and profitability.

How to Reduce Burn Rate?

To reduce the burn rate effectively, you must focus on decreasing expenses and increasing revenue. Here are several strategies you can do to achieve this:

Optimize and Reduce Expenses

When the burn rate increases, optimizing or cutting expenses is necessary, as expenses are directly related to it. Assess any non-essential expenses that can be cut without harming the businesses. You can also focus on activities directly contributing to revenue generation or significant growth opportunities.

Increase Revenue

Boosting your income is just as crucial as cutting down expenses. Explore ways to enhance revenue through improved marketing, increasing traffic, or raising prices strategically. A small price increase can impact gross margins without drastically affecting customer conversion rates.

Implement the Lean Startup Method

Adopting a lean startup approach may be beneficial by minimizing expenses across your business operations as you seek product-market fit. This approach focuses on building businesses based on testing along with developing products. It means continuously evaluating and improving processes to make them more efficient.

Outsource Non-Core Activities

You can consider outsourcing to handle non-core activities in your company, as it helps reduce expenses related to maintaining internal employees. Outsourcing can also convert fixed costs into variable costs, offering flexibility and business efficiency without compromising quality or capacity.

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Accelerating business growth and realizing business ideas would be easier with the right partner. Phintraco Natha Kapital is a trusted partner to support business’ long-term success, blending strategic investment with innovative support to help your startup thrive. As a capital company with a diverse investment portfolio from ICT, property, manufacturing, and education sectors, we go beyond providing capital. We also deliver tailored advisory services and strategic guidance to support the people behind the business. Supported by the reputable Phintraco Group, our vast network and industry connections enable us to forge valuable partnerships and unlock new opportunities. Whether you are an established business seeking leverage or a promising startup, we are committed to supporting you in reaching success.Editor: Irnadia Fardila