How To Calculate Burn Rate And Why It’s Always Asked On Shark Tank
By Gregg Jackowitz, Managing Director, Bond Collective
If you want to be successful as an entrepreneur or startup owner, you need to speak the language. And in the first months and years of your business, there are few terms as vital as burn rate.
Your startup’s burn rate is a key indicator of the strength of both your business plans and business practices. It’s no wonder, then, that the sharks on the television show Shark Tank make it a point to ask each entrepreneur about their burn rate.
Indeed, understanding and controlling the variables associated with burn rate can mean the difference between launching your startup into the business stratosphere and crashing back to Earth.
But what exactly is burn rate? Why do the sharks on Shark Tank always ask about it? And how can you calculate your startup’s burn rate for yourself? In this article, the experts at Bond Collective will tell you everything you need to know about this important concept.
What Is Burn Rate?
Burn rate is defined as the rate at which your business is spending money to cover overhead (rent, electricity, HVAC, technology, wages, supplies, etc.) before generating positive income from sales and operations.
Most businesses measure burn rate (or just “burn” for short) in months. But in extreme cases, you could also measure it in weeks or even days. This measurement is a concept called “runway,” which we’ll discuss in detail in the next section. For now, we’ll measure burn rate in dollars.
At the most basic, burn rate is a measure of negative cash flow (how much money you’re losing each month). For example, if your startup spends $10,000 every month on office space, computers, and wages, but sales only amount to $8,000 in that same month, then your burn rate is $2,000 ($10,000 - $8,000).
As simple as that may sound, there are actually two types of burn rate — gross and net — each with its own unique indicator.
Gross Burn Rate
Gross burn rate is your business’s total costs. It’s usually divided into items like manufacturing, shipping, and operating expenses, just to name a few. With gross burn rate, you lump everything together into one variable. That variable is the only one considered.
So if your monthly expenses are $10,000, your gross burn rate is $10,000. That’s how fast you’re burning through your cash on hand without factoring in revenue.
Net Burn Rate
Net burn rate is equal to total costs minus revenue. It’s usually divided into all the operating expenses mentioned above, plus whatever income your startup brings in. Compared to gross burn rate, net burn rate gives you a more detailed picture of your business.
For example, if your monthly expenses are $10,000 and your revenue from sales is $8,000, then your net burn rate is $2,000. That means, barring any other factors (e.g., sales fluctuations, changes in costs), you’ll burn through $2,000 of your cash on hand every month.
When Someone Says “Burn Rate,” Which One Do They Mean?
When you hear someone talking about burn rate, always assume they are referring to net burn rate unless they say otherwise. This is because net burn rate is by far the more descriptive of the two terms.
Why Do The Sharks On Shark Tank Ask About Burn Rate?
The sharks on Shark Tank are savvy investors. They know how important numbers are to the success of a business. They also know that your burn rate is a key indicator of your startup’s sustainability.
Burn rate gives investors like the sharks a timeline for when your business will run out of money.
That is called your “runway.” Think of it as how much room you have to become profitable before your business fails.
It also gives them an idea of what it will take for the business to become profitable. Investors measure burn rate against future revenues to gauge if your startup is a worthwhile investment.
If you’re burning through $100,000 a month, it’s going to take a significant amount of revenue just to break even. It’s also going to take substantial capital to keep your business afloat until it can turn a profit. That might not be a smart investment.
That’s why the sharks on Shark Tank always ask about a business’s burn rate. They know that it’s an outward sign of the health of your company and that it can indicate a good investment or a bad one.
How Do You Calculate Burn Rate?
Figuring out your gross burn rate is simply a matter of adding up your expenses for the month. Determining your net burn rate then involves subtracting your income from those monthly expenses.
If your expenses are more than your income, you’ll have a deficit every month (and, therefore, a burn rate). If your expenses are less than your income, you’ll have a profit every month and burn rate won’t apply because you’re bringing in more money than you are spending.
While the above calculation is simple enough, it’s when we get into burn rate runway that things get a little more complicated. That said, the equations for the two types of burn rate runway are pretty straightforward.
All you need are three numbers:
Cash on hand
Monthly operating expenses
Here’s how to calculate your gross and net burn runway.
Gross Burn Rate Runway
Gross Burn Rate Runway = Cash / Monthly Operating Expenses
Gross Burn Rate Runway = $100,000 / $10,000
Gross Burn Rate Runway = 10
That number tells you that, without any income or changes in expenses, you have enough money to pay your bills for 10 months.
Net Burn Rate Runway
Net Burn Rate Runway = Cash / (Monthly Operating Expenses - Income)
Net Burn Rate Runway = $100,000 / ($10,000 - $8,000)
Net Burn Rate Runway = 50
That number tells you that, without any changes in income or expenses, you have enough money to pay your bills for 50 months.
Ideally, you want to get your monthly operating expenses as low as possible and keep them consistent from month to month (within a few hundred dollars). That changes the number from a variable expense to a constant expense and gives you more control over your burn rate.
You can’t maintain your income with quite the same precision as you can your operating expenses, so this is the real variable in the equation. Obviously, the higher your revenue (and the lower your operating expenses) the longer you’ll be able to stretch your burn rate.
Keep Your Burn Rate As Low As Possible
As you can see from the information above, keeping your burn rate as low as possible is always a good idea. That means minimizing your regular monthly expenses.
One of the largest of those expenses is office space. Office space is a necessity, but it doesn’t have to break the bank. Instead of leasing your own building, opt for coworking space from Bond Collective.
Not only can you choose from open-concept spaces, dedicated desks, and private offices, but you can also access conference rooms, meeting spaces, and reception areas. And that’s just the tip of the iceberg.
At Bond Collective, you also get:
Incredibly fast Wi-Fi
Private label mail service
Daily on-site cleaning
Concession food market
And if you’re concerned about keeping up a professional appearance, rest easy. At Bond Collective, we’ve designed our workspaces with your team’s happiness and productivity in mind.
Each of our seven locations incorporates inspiring design elements like natural light, open floor plans, vivid colors, and multipurpose workspaces, along with a whole host of other design factors that will motivate your team to greatness.
Think of all the time and money it would take to build that yourself. There would be no way to keep your burn rate low if you leased and retrofitted a building on your own.
But with coworking spaces at Bond Collective, you can get everything you need to nurture your startup to success at a fraction of the cost of a standalone space.
That makes Bond Collective the wise choice for entrepreneurs, startups, digital nomads, and businesses of all sizes who want to keep their overhead low while maximizing their space. Even enterprises and large businesses are discovering the benefits of moving a few teams — or even all their employees — into coworking spaces like Bond Collective.