What is burn rate and how do you manage it?

May 30, 2023 | Start a Company

Maintaining “a healthy burn rate” and budgeting effectively are core responsibilities for any founder. Knowing where to allocate money, and how much, will not only determine the startup’s trajectory but also whether it survives at all. So what do first-time founders need to know?

What is burn rate?

Burn rate is the rate at which a startup uses up its available capital. How much is being spent every month to cover expenses. It’s often used in combination with the company’s available cash and its “runway” (the number of months the company can sustain itself at the current rate of income and spend).

If you have $1m in the bank and your burn rate is $100k/month, then you have 10 months of runway.

For early-stage startups, managing burn rate is crucial to providing sufficient time and resources to iterate, build, and grow before the company either raises more capital or reaches profitability.

N.B. In the example above, the company’s actual runway is probably more like 7 months. As a responsible founder, you need to set aside sufficient capital to be able to pay creditors and liquidate the company, if things don’t go as planned.

Why manage burn rate?

Effective allocation of resources

A well-managed burn rate allows startup teams to understand what resources they have available and for how long. This means entrepreneurs and their teams can allocate resources in areas that will move the needle most effectively on their core metrics, i.e. the factors that will have greatest impact on either their ability to generate cash flow or investment. These may include product development, marketing, sales or talent acquisition, for example.

Confidence

Another benefit of managing burn rate is confidence. Startups that have a good grasp of their numbers and metrics inspire confidence in their employees and, just a importantly, in existing and potential investors. Financial discipline is a strong indicator of a founder’s ability to run an efficient, organised business with good governance. A controlled burn rate also demonstrates the team’s commitment to long-term success, which can be a significant contributor to future fundraising efforts.

Runway

Effective burn rate management extends the financial runway, providing more time for experimentation, market validation, and achieving key milestones. This additional runway can be particularly important when startups need to iterate, refine or even pivot their business models, as they aim to identify a path to profitability.

How to manage burn rate

To have a chance of managing burn rate effectively, every company needs a budget. A budget is not meant to be correct, it’s a best guess at what the future looks like, and provides a benchmark against which founders can measure their progress.

Budgeting helps entrepreneurs identify softness in their operations – where are revenues lower than expected? Where are the unexpected costs?

With this information, management teams can make informed decisions while maintaining financial discipline, allocating resources in the areas that need them most. It’s the difference between flying blind and following a clearly plotted journey. Only if you can see that you’ve strayed off-course can you make the necessary corrections.

Here are some key components of effective budgeting:

Revenue forecasting

Develop realistic revenue projections. These are the foundation of any budget. If you miss your revenue targets, you’ll recognise immediately that either your strategy is not working, your team is not implementing the strategy effectively, or the foundational assumptions that support that business are wrong. Creating a forecast is as much art as science, and is usually based on a blend of historical data, market research, competitor analysis and benchmarking.

Expense management

Categorising, approving and tracking expenses allows startup teams to monitor and keep control of costs. It’s all-too-easy to allow expenses to get out of control, so someone needs to be vigilant and keep an eye on expenses at all times. In the early days of a startup, it’s wise to restrict expenses as much as possible, ensure everyone follows a strict approvals process, and prioritise what is essential to running and growing the company. In other words, spend on core operations and customer acquisition, and avoid office parties (at least for a while).

Contingency planning

The best startups are adept at handling the unknown. They experiment, test hypotheses and have contingency plans. Founders must understand that market fluctuations, unforeseen expenses and changes in the funding landscape are par for the course. Every startup should allow for a margin or error, with a financial safety net to allow for unexpected challenges or perhaps even company closure. Depending on location, there can be severe consequences to company directors who cease operations and leave creditors unpaid.

Monitoring and adjustment

As mentioned earlier, the value of a budget is not its ability to predict the future, but its role as a means of tracking progress. Founders should actively monitor their financial performance and regularly review and adjust budgets based on actual results. This iterative process enables entrepreneurs to identify false assumptions, spot inefficiencies, optimise spending, and make informed decisions about their business.

Scalability and flexibility

Because they are almost never accurate, all budgets should be flexible. As companies evolve and grow, budgets need to accommodate changing priorities, opportunities and potential expansion, allowing the business to adapt to market dynamics.

In summary

The importance of managing burn rate and implementing effective budgeting practices cannot be overstated for early-stage startups. These are fundamental skills for anyone operating a business. Without a budget and control of costs, founders have little hope of executing any kind of plan, but instead will find themselves reacting to surprises and fighting fires. Startups that prioritise financial rigour give themselves the best chance of executing on their vision, being resilient, attracting investors and laying a strong foundation for long-term success in today’s competitive startup ecosystem.


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– Midjourney

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