Money Management

3 Important Burn Rate Considerations for Every Business

3 Important Burn Rate Considerations for Every Business
Image credit: Wes Peck | Flickr

Burn rate is something every entrepreneur needs to be familiar with, whether you’re intending to go after venture capital or not. While burn rates are most closely associated with valuations and capital raising for startups, there are important aspects of your business’s bottom line with or without VC money.

You may immediately be tempted to think that the obvious advice is spend less, have a smaller burn rate and preserve your capital for operations as long as possible, however that’s not always the case.

Related: How Much Money Should Your Startup Be Burning Through?

Here are three important burn rate considerations for every entrepreneur to know and understand. What makes sense for your business will be unique to your needs, but a basic comprehension will give you a leg up in operating capital.

1. Understand net vs. gross

The difference between the terms net and gross is important for your accounting and for your burn rate comprehension.

An entrepreneur’s gross burn rate means the total amount of capital you’re spending monthly. That’s going to include all your outgoing cash flow for all your operations to keep the business running. Your net burn rate on the other hand is your monthly loss.

What’s the difference? The best way to explain it is with some easy rounded numbers. Let’s say your business in spending $50,000 in operating expenses, but you’re making $25,000 in profit each month from monthly subscriptions for your product or service. Your monthly gross burn rate is $50,000 because regardless of business revenue, that’s how much you’re spending. However, your net monthly burn rate would only be $25,000, since you’re spending $50,000 but bringing in $25,000.

Most VCs and entrepreneurs are going to pay attention to that net $25,000 burn rate number, but keep in mind your overhead because if profits drop, you will either have a large increase in net burn rate, depleting your cash on hand, or you’ll have to decrease your gross burn rate to compensate for the profit loss to keep your net burn rate the same.

Know the difference between these two key figures so you can keep a healthy perspective on your overall operational bottom line.

Related: Grow Your Business Without Drowning in Debt

2. Burn vs. opportunity

It’s easy to think that you want to reduce your burn rate to preserve your operating capital, but there are forgone opportunity costs to consider when factoring your burn rate. Often, a greater output in capital can correlate to a drastic leap up the learning curve as you operate and scale your business. You’ll have to carefully consider what you’re spending money on to decide whether it’s more prudent to save the cash, or scale your growth faster.

If a huge leap in growth comes at the expense of a reasonable increase in gross monthly burn, it just might be worth it to increase your spending. Consider the cost of slower growth, missed opportunities and the affects those could have on your business in the long-term, not just the short-term effects of increasing your spend.

3. Not all burn is create equally

Related to point number two, not all burn rate spending is bad or good. As the creator of your business the tough decisions of what to spend money on are ultimately up to you decipher. Just remember that not all kinds of burn are created equal.

I’ve long been an advocate of keeping staff and office space overhead low to leverage monthly capital into systems and operating structure that can scale faster. If you had $10,000 a month available for gross burn, you could choose to spend $1,500 of that on an office lease, $3,500 on staff and be left with 50 percent of your budget to actually grow and scale the business.

I have always preferred to try to keep outsourced labor and contractors, which tend to offer project-specific budget spending vs. ongoing daily salary and try to keep office space to a minimal, at least when starting out. It’s up to you to decide which type of expenses are going to move the needle the most for your business, but consider the implications of large overhead spends such as leases and staff and what that operating capital might be able to do for your business overall before committing to that gross monthly burn.

Related: 10 Ways to Keep Your Company's Cash Flow Alive