Burn rate is a term used to describe the rate at which a start-up business devours its capital resources. It is an important financial metric that can be used to reliably predict the lifespan of a business before insolvency occurs. A company’s burn rate is calculated by measuring the amount of cash outlay a company has on a monthly or yearly basis. This calculation typically will include all short-term financial obligations, minus any short-term estimated revenue.

A business’ burn rate is calculated in two forms, the gross burn and net burn rate. The gross burn rate includes all the cash outlayed from operating costs of a business such as salaries, expenses, rent and utilities. The net burn rate is the difference between the money earned each month, minus the money going out for expenses incurred in running the business. By subtracting revenue from costs, the net burn rate gives an accurate picture of how much cash the business loses each month.

The burn rate measure how much financial runway a business has before it runs out of available capital. To counter an high burn rate, some companies choose to raise additional capital or ‘re-burn’. Re-burn is when a company quickly raises more money, presumably at a higher valuation than the previous round, to increase the budgeted runway to prevent complete exhaustion of reserves. However, this type of approach should be taken with precaution due to its risk factor.

The burn rate can be an accurate indicator of a new business’s health, as high rates can signal unsustainable spending and a lack of financial control. It is important for companies to monitor their burn rates, as they form a critical component in the long-term success or failure of a business. This a key metric entrepreneurs should focus on, to ensure their start-up achieves the desired level of success.