Burn Rate: Don't Let Your Startup Burn Out
Understand your startup's burn rate!
Understand your startup's burn rate!
In the fast-paced realm of startups, the exhilarating pursuit of innovation and growth often goes hand in hand with the pressing challenge of managing finances. Just as a successful F1 racer maintains the delicate balance between speed and nimbleness, startups must master the intricate interplay between their ambitions and their available resources—knowing when to hit the gas and when to ease on the brakes. Welcome to a deep dive into the world of burn rate—a crucial metric that can spell the difference between the checkered flag of success or crashing and burning out.
It’s no surprise the cash situation of a startup must be monitored closely. What’s the correct blend between keeping an eye on reality and an eye in the sky— because the big picture doesn’t keep the lights on in the interim, does it? According to CB Insights, 29% of all startups exhaust their financial resources and are forced to close their doors. Running out of capital is second to a lack of product-market fit as the leading cause for startups fizzling out. The balancing act is one founders should take very seriously, much like a tightrope walker. Focusing too much on the glory and success at the end of the line will cloud the present, stealing focus from the here and now, and could lead to a grim and fatal fall. This paints a vivid picture of the significance of burn rate—the rate at which a startup expends its cash reserves to sustain operations.
It’s not about financial health; it’s about survival.
Like the animal kingdom, the survival of the fittest hypothesis applies to startups. Therefore entrepreneurs must learn to monitor their burn rate carefully—emphatically understanding their company’s expenses to determine how much runway their cash situation provides them. Companies need to know how much they’re spending on salaries, marketing, rent, accounting, legal, travel, and more, on a monthly basis to begin predicting future months with greater accuracy.
Suppose accurate financial forecasts are a startup’s compass. In that case, the ability to decipher how your burn rate is affecting your cash flow situation is a north star to becoming a financially intelligent founder. By linking this concept to the precision of the financial statements, startups can draw a roadmap to navigate their financial journey, with their burn rate acting as a real-time gauge of stability. Using this gauge to confirm runway will set the founder up for greater success, as they’ll be able to plan, react, and make decisions—such as knowing when to raise capital before it’s too late—with a higher degree of certainty.
To truly appreciate the significance of burn rate, it’s essential to grasp its intimate relationship with cash flow. The statistics speak volumes—82% of small businesses fail due to cash flow problems. This underscores that a declining burn rate should not be misconstrued as an aversion to risk but rather as a strategic approach to optimizing cash flow and preserving runway. There are many ways a company can tighten its operating expenses; however, it must be cognizant that salaries usually represent 60% or more of the monthly operating expenses. Therefore, hiring must be done precisely and strategically, ensuring that the most challenging operating expense to decrease doesn’t get out of hand and put the founder in a vulnerable position. Startups must tread the fine line between expansion and fiscal prudence.
In the intricate choreography of startup finances, there’s a generally accepted formula to determine runway quickly:
Runway = Cash ÷ Monthly Operating Expenses
This simple calculation quickly shows how many months a company has remaining before they run out of cash. Constantly checking in on your cash balance, burn rate, and runway are best practices for financially intelligent founders, and enforce the forward-looking approach that Profitual recommends because it informs more realistic and accurate financial forecasts.
In today’s economic situation, Profitual encourages startups to aim for 18-30 months of runway when raising capital. Leveraging cash for this long should allow startups to reach their lofty growth goals and ensure their financial endurance.
Just as the F1 racer attains mastery of the track through discipline and practice, startups, too, can thrive through increased financial intelligence. Burn rate encapsulates the essence of financial intelligence and sound decision-making, weaving together the threads of accurate forecasting and, most importantly, knowledgeable founders. The startup journey is not linear; it’s much more similarly laid out to a Formula 1 track—full of unpredictable twists and turns—which requires founders to know exactly when to brake around uncertainties and speed toward success. Knowing the burn rate, cash balance, and runway is one of many key metrics to help a founder reach their financial checkered flag.