Hello everyone and welcome to The Shades of Entrepreneurship - this is your host, Mr. Gabriel Flores.
Today I welcome a serial entrepreneur who has sold a couple of start-ups to some big names in the tech world, and he is the co-founder of Pilot, a finance, accounting, and tax services for startups and growing businesses, Waseem Daher.
As I began to browsing Pilot’s website I came across their resource page and stumbled upon the burn rate calculator: calculate your burn rate and startup runway, which got me thinking.
What is a burn rate calculator, why is it important, and why should an entrepreneur care?
Now let me start out by saying this information can be found on pilot’s website, including 20% off for The Shades of Entrepreneurship listeners (must be used in the next 6 months!).
The burn rate is the pace at which a new company is running through its startup capital ahead of it generating any positive cash flow. The burn rate is typically calculated in terms of the amount of cash the company is spending per month, according to Investopedia.
In short, burn rate is the actual amount of cash in the entrepreneur’s account has decreased by in one month, per pilot.
According to pilot, most of the time, it describes a company’s negative cash flow. It doesn’t include outstanding obligations, money that was transferred into another account, or money that’s on its way. It is truly a snapshot of a specific amount for a specific time frame.
Here is an example of burn rate:
A company has $1 million cash in the bank and is spending $100k a month. Take 1,000,000/100,000 = 10 months left of cash until the company is out of cash in that bank account. Again, not taking into account outstanding balance, other accounts, money on the way - only cash in the bank (there are burn rate calculators online).
Pilot highlights two different burn rates: net burn rate or gross burn rate.
Gross burn rate is the amount of cash that the entrepreneur spent in a single month. It does not take total revenue (incoming cash) into account.
Net burn rate takes the incoming revenue from cash into account. So net burn rate is the entrepreneur’s cash lost in a single month.
To simply things, pilot refers to net burn rate and gross burn rate as burn rate - visit pilot for more information about burn rate calculator.
But why is any of this important? If an entrepreneur burns through their cash too quickly, the entrepreneur runs the risk of running out of funds to keep the business going.
Business failure rate in the US within the first year is about 20% (18.4% to be exact according to LendingTree BLS data), and one of the biggest reasons entrepreneurs fail is because of cash flow.
According to CB Insights, 38% of failed startups point to running out of cash and not being able to raise new capital as the central issue.
Furthermore, according to a May 2021 LendingTree survey, 40% of surveyors said not having enough money was what was keeping prospective entrepreneurs from starting their own business.
A burn rate calculator can be used for any entrepreneur, at any stage in their career.
As pilot states, the burn rate calculation can be used to calculate runway (i.e., the number of months the entrepreneur has left before the entrepreneur runs out of cash).
Since burn rate reflects the net cash that left in the entrepreneur’s account in a month, the entrepreneur can use that trend to extrapolate, which means to estimate or conclude, and see how many months it would take before the entrepreneur “burns” through the cash balance.
This is also true for personal finance. Use a burn rate calculator to determine the entrepreneur’s personal rainy day fund - a rainy day fund is a small amount of money for unexpected expenses.
There are mainly two options to reduce burn rate: increase revenue or cut costs, i.e., marketing, vendor relationships, office space, staffing.
Increase revenue by focusing on core competencies. Pursing every idea is a quick way to divert from those core competencies.
Unfortunately, we are seeing cost cutting measures being taken place on local and national levels including reduction of staff, and that is why an entrepreneur should care.
The burn rate calculation is a financing tool. It is intended to paint a picture of the entrepreneurs financial state.
Life comes at us fast. Understanding our current financial state is important incase the unthinkable happens. Like the old GI Joe cartoon said, “knowing is half the battle”.
And if the entrepreneur needs some help, hire a pilot.