In Finance, what is a Burn Rate?

Malcolm Tatum
Malcolm Tatum

Burn rate refers to the pace at which a business utilizes funds invested in the company by investors. Also known as burning rates, burn rates vary from one business situation to another, and may be impacted by factors such as the operating strategy of the business owner, the cost of raw materials, and how quickly the company can begin to generate revenue from its production efforts. Ideally, businesses are able to establish a burn rate that allows for the money invested to carry the operation all the way through to the posting of the first profit.

Man climbing a rope
Man climbing a rope

The burn rate is often understood as a negative cash flow. This is because in the early stages of the business, money is being spent, but no money is coming in. As the business begins to sell products, the rate of this negative cash flow is impacted, since the first trickles of revenue from sales helps to offset the drain on the funds provided by the shareholders. Only one the business has grown to the point of operating solely on revenue collected from the sale of products does this negative cash flow situation cease to exist.

When starting a new business enterprise, one of the most important factors is to determine how much capital is needed to handle startup costs and continue the operation as it begins to produce goods or services and connect with consumers. Under ideal circumstances, the business owner can secure enough funds from several investors to allow the business to get established and reach a point where it begins to turn a profit. Depending on the business model and the type of products produced, investors may need to provide funding for no more than a couple of years. With more involved business operations, it may take several years before the business is able to generate enough revenue to become self-sustaining and post a profit.

As part of the planning process, business owners must go beyond simply determining how much capital is needed to launch the business and keep it in operation until it becomes profitable. There is also the need to define how quickly those cash reserves from shareholder investing will be consumed. This involves conducting a burn rate analysis to create a workable schedule for the use of that capital. Without some sort of budgeted approach to managing the burn rate, there is a very good chance that the available funds will be consumed much faster than necessary, with part of that consumption going toward expenses that could have been avoided. If the capital is burned or consumed at a rate that outpaces the progress toward self-sufficiency, the business must either seek additional funds to continue, or shut its doors forever.

Malcolm Tatum
Malcolm Tatum

After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including wiseGEEK, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.

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