Burn rate: Definition, formula, and example calculation

Burn rate explains how quickly your business is using up its cash reserves. It’s a metric that helps your startup (and investors) understand exactly when you’ll need to raise more funds before your business stalls out.

Founders and investors use burn rate to see how the business manages its most precious resource: cash. It shows how much cash you have, where your money goes, how your business operates, what you prioritize, and plans for the future.

It matters because your business’s cash burn rate directly impacts your runway—the amount of time you have before the money runs out and you either:

• Become profitable

• Secure more funding

• Face closure

A high burn rate dramatically shortens your runway, leaving less room for error or experimentation—it’s a quick-moving hourglass you don’t want to shake up. However, a controlled burn rate extends your runway, giving you more opportunities to pivot, test, invest, grow, and succeed.

Below, we’ll walk you through everything you need to know about burn rate to calculate your startup’s financial health and take control of your runway.

What is burn rate?

Burn rate is a financial term that illustrates the speed at which a company exhausts its cash reserves or cash balance over a given period (usually measured on a monthly basis). Startups and early stage companies closely monitor this metric because they tend to operate at a loss as they focus on rapid growth and expansion before profitability.

That’s natural, but negative cash flow isn’t sustainable forever. Eventually, startups need to turn a profit instead of asking banks or investors for more money. You’ll need to closely monitor your cash burn rate to understand where your money is going and whether you’ll run out too soon.

Monthly burn rate isn’t just about the money being spent—it’s about where that money is going and ensuring it’s used to support your company’s long-term growth objectives.

Types of burn rate

When talking about burn rate, you need to differentiate between the two main types: gross burn rate and net burn rate. Each provides unique insights into your startup’s financial situation and, used together, offers a comprehensive view of your cash flow health:

• Gross burn rate: This measures the total cash your company spends a month before any income. It includes all operating expenses such as salaries, rent, utilities, and marketing costs. It’s a straightforward metric highlighting the total cash outflow, providing a clear picture of your company’s spending patterns.

• Net burn rate: Net burn rate takes into account your company’s revenue. It is calculated by subtracting the monthly revenue from the gross burn rate. This figure helps you understand how current income impacts your company’s cash position and ability to extend its runway. A lower net burn rate (especially one that trends towards zero or becomes positive) indicates that your company is moving closer to profitability or financial sustainability.

Gross burn rate offers insight into the company’s operational efficiency and cost management, while net burn rate shows the impact of revenue generation activities. Use both of these metrics to guide your decisions around spending, investment, and growth.

How to calculate burn rate

First, you need reliable financial data to calculate your burn rate. Without accurate and up-to-date financials, your burn rate calculation won’t do you much good. Once you have those metrics, it’s time to calculate both the gross and net burn rate for your startup.

Calculating gross burn rate

The gross burn rate is more straightforward to calculate because it doesn’t factor in any incoming cash flows. It purely focuses on your cash outflows. Here’s how to calculate it:

1. Monthly expenses: Gather all your company’s expenses over a month. This includes operational costs like salaries, rent, utilities, marketing expenses, and any other costs incurred to keep the business running.

2. Total expenses = gross burn rate: The total of these expenses represents your gross rate.

Gross burn rate formula: Gross burn rate = Total monthly expenses

For example, if your startup spends $50,000 on salaries, $10,000 on rent, $5,000 on utilities, and $15,000 on marketing in a month, your gross rate is $80,000.

Calculating net burn rate

The net burn rate offers a more nuanced view by accounting for your startup’s revenue. Here’s the process:

1. Calculate your gross burn rate: Follow the steps outlined above to determine your total monthly cash expenses.

2. Subtract monthly revenue: Identify the total revenue your company generates in the same month. Then, subtract this amount from your gross rate to find your net rate.

Net burn rate formula: Net burn rate = Gross burn rate - Monthly revenue

Continuing with the previous example, if your startup also generated $20,000 in revenue during the month, your net burn rate would be $60,000 ($80,000 in total expenses minus $20,000 in revenue).

Calculating cash runway

Once you have your burn rate, you can calculate your cash runway, which is how long your company can operate before it runs out of cash. To find this:

Cash runway formula: Runway = Current cash reserves / Net burn rate

For example, if your startup has $240,000 in the bank and a net rate of $60,000, your runway is 4 months ($240,000 / $60,000).

10 strategies to take control of your burn rate

Your company’s burn rates aren’t set in stone. You can take action to control it and extend your runway. Below, we’ll share a few strategies for reaching financial stability.

However, remember that you don’t need to use all the strategies. Every startup has different goals and unique situations. You might be better off prioritizing growth rather than profitability. In that case, you don’t want to dramatically reduce your burn rate—that’d hurt your growth. Instead, you might want to use a strategy or two to take control rather than overhaul your financial plan.

1. Prioritize spending based on ROI: Focus your spending on areas with the highest return on investment. This means allocating resources towards activities directly contributing to revenue generation or significant growth opportunities, like content marketing or conversion rate optimization.

2. Improve revenue streams: Increasing your income is as important as reducing cash spent. Look for opportunities to diversify and enhance revenue streams. This could involve introducing new products or services to your product roadmap, improving sales strategies, or entering new markets.

3. Outsource non-core activities: Consider business process outsourcing functions that aren’t central to your business, such as administrative tasks, HR, and specific IT services. Outsourcing can convert fixed costs into variable costs, offering flexibility and potential cost savings without compromising quality or capacity.

4. Implement lean operations: Adopt a lean startup approach by minimizing waste across your operations as you seek to find product-market fit. This involves continuously evaluating and improving processes to make them more efficient.

5. Renegotiate contracts and expenses: Regularly review and renegotiate contracts with suppliers, service providers, and landlords. Market conditions change, and there may be opportunities to secure more favorable terms or discounts.

6. Monitor cash flow closely: Implement a rigorous cash flow management system. Regular monitoring allows you to identify trends, forecast future free cash flow, and make informed decisions about where and when to cut costs or invest in growth opportunities.

7. Leverage technology: Technology can offer cost-effective solutions for many business processes. For example, building with DigitalOcean can help you find the best mix of cloud solutions to meet your business’s unique needs without breaking your budget.

8. Optimize inventory and supply chain: Optimize your inventory levels and streamline your supply chain to reduce holding costs, minimize waste, and improve cash flow.

9. Engage your team in cost control: Make cost awareness and efficiency part of your company culture. Engage your team in identifying savings opportunities and improving workflows.

10. Plan for financial cushions: Aim to secure a financial cushion beyond your immediate needs. This might involve raising more funds than you think you need or establishing lines of credit before they’re needed.

Take control of your startup with DigitalOcean

Managing burn rate isn’t just a financial exercise—it’s a core part of your startup’s growth strategy. You’ll have to calculate and monitor this metric to define your trajectory and keep your business on course.

Fortunately, you don’t have to navigate these challenges alone.

DigitalOcean offers a suite of cloud computing solutions designed for startups like yours. We provide the tools and resources to build, deploy, and scale applications efficiently and cost-effectively.

• Affordable solutions: DigitalOcean provides transparent, predictable pricing that helps manage your company’s burn rate effectively. With scalable resources that can be adjusted according to your startup’s needs, you can optimize your spending without compromising performance or reliability.

• Simple and straightforward: Our platform is designed to be clear and easy to use, allowing you to focus more on your product and less on managing infrastructure. This simplicity translates into faster development cycles and reduced operational overhead.

• Community and support: DigitalOcean’s community and comprehensive documentation provide valuable resources for troubleshooting, learning, and growth.

• Secure and reliable infrastructure: Our globally distributed data centers guarantee that your applications run securely and reliably.

Ready to reduce your burn rate and accelerate your growth? Start building with DigitalOcean today to take the first step towards a more sustainable future for your startup.