Cash Burn Rate

Article byWallstreetmojo Team
Edited bySusmita Pathak
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Cash Burn Rate?

Cash burn rate is cash spent or used over specific time which can be determined through cash flow statement and it indicates the negative cash flow, this rate is normally calculated by start-ups and business which is used to analyze the cash spent or expenditure for generating revenue or cash flows.

Cash Burn Rate

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Cash burn rate, of course, signifies the frequent cash expenditure of a firm, but calculating it gives firms, both established and start-ups, to know when it is time to control cash outflow and raise more funds. In addition, burn rate calculation also helps in making effective financial decisions.

Cash Burn Rate Explained

Cash Burn Rate is an effective metric to keep a check on how frequently a company spends its cash. As a result, it remains informed about its cash status and hence can keep control when required. On the other, if this rate is not taken care of, the companies are likely to run out of cash.

The burn rate helps businesses be aware of the period for which it can operate before running out of cash. The firms that have just started up get an opportunity to identify the time when they should begin raising funds. They make sure to finance their venture before they lose all the cash.

When we look at the graph above, we note that Snap’s Inc share prices have declined close to 40% from its IPO price of $24.48 to $15.15 (currently). This is primarily due to the very high burn rate and missed revenue targets. We will look at how Snap’s cash burn rate is calculated later in the post.

Cash Burn Rate

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Types

Cash burn rate exists in two forms – gross burn rate and net burn rate.

  • The gross burn rate includes the total amount of cash that a firm spends in a month. It is recorded in the profit and loss statement, cash flow statement, and balance sheet.
  • The net burn rate indicates the total amount of cash that companies lose per month. It is recorded as net income in the profit and loss statement.

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Video Explanation of Cash Burn Rate Analysis

 

How To Calculate?

The cash burn rate calculation is done keeping in mind the following steps:

Cash burn rate Calculation is relatively easy.

Step 1 – Time Period For Cash Burn

In the first step, you need to zone when you calculate the cash burn rate.

For example, let’s say that you want to know the cash burn of your start-up during the first quarter (i.e., January to March). Then, it would help if you looked at the opening cash balance at the beginning of the time and the closing balance at the end of the period. In our example, we would look at the opening cash balance on January 1. And we will also look at the end balance on March 31.

  • Let’s say that on January 1, the cash balance is $20,000.
  • And at the end of the period, the cash balance is $11,000.

That means during these three months, you burned cash of = ($20,000 – $11,000) = $9000.

Step 2 – Divide Cash Balance by Time Period

All you need to do is divide the difference between the opening balance and the ending balance by the number of months.

  • In our example, the number of months for the period is three months. And the difference is $9000.
  • That means the cash burn for the period of the start-up would be = ($9000 / 3) = $3000.

Formula

Finally, the formula to calculate the cash burn rate is:

Net Burn Rate = (Monthly Revenue – Cost of Goods Sold) – Gross Burn Rate

Where,

Gross Burn Rate = Total Monthly Operating Costs

Calculation Example

Let us consider the following example to understand the cash burn rate meaning and its calculation:

Ding Dong Inc. is a start-up company. It is aiming for venture capital funding. Thus it wants to look at its cash burn rate for the last quarter of the year. Here is the following information is given for calculating the cash burn rate –

  • Cash flow at the beginning of the quarter – $45,000.
  • Cash flow at the ending of the quarter – $15,000.

Since the business has been dry, Ding Dong’s sales for the quarter were just $30,000. Is it enough for the start-up company to remain sustainable? Compare it with the cash burn.

This is a simple example.

All we need to do is to follow the step by step process to first ascertain the cash burn rate, and then we will compare with the sales.

The first step is to calculate the difference between the beginning cash balance and the ending cash balance of the last quarter of the year.

The difference is = ($45,000 – $15,000) = $30,000.

Now we need to divide the difference by the number of months in the period to find out the burn rate.

The cash burn of Ding Dong during the last quarter of the year is = ($30,000 / 3) = $10,000.

It has been mentioned that the cash flow for the company was dry during the last quarter. And it could only make revenues of $30,000 during that time. That means the revenue for each month was = ($30,000 / 3) = $10,000 as well.

Since the cash burn is also $10,000, we can easily say that Ding Dong is not in a very good position.

To be able to attract venture capital funding, it has to improve its sales and its cash flow. It is currently in a situation where the cash burn and the cash inflow are exactly the same. That means what the organization has been earning; it’s burning right away.

Calculating Snap Inc Cash Burn Rate

Now that we know how to calculate the cash burn rate with examples let us apply our knowledge in Snap’s example.

In March, Snap Inc raised over $2.6 billion in its IPO, giving it an overall valuation of $20 billion!

Snap IPO Proceeds

source: investor.snap.com

A significant amount of money raised by Snap Inc was invested in Marketable Securities.

Snap Purchase of marketable Securities

source: investor.snap.com

Let us look at Snap’s Cash Position as of March 31, 2017
Snap Cash Burn Rate March

source: investor.snap.com

Please note that I am adding marketable securitiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it.read more here as the company has invested a sizable portion of its IPO money in the same. This will help us correctly calculate the Cash Burn Rate.

Snap’s Cash and Cash Equivalent as of September 30, 2017
Snap Cash Burn Rate September

source: investor.snap.com

  • Cash Position of Snap Inc (September 2017) = Cash and Cash Equivalents (September 2017) + Marketable Securities (September 2017).
  • Cash Position of Snap Inc (September, 2017) = $317,554 + $1,980,514 = $2,298,068
  • Cash Burn Rate of Snap Inc in six months (March 31 until September 30, 2017) = Cash Position as of September 30, 2017 – Cash Position as of March 31.
  • Cash burn of Snap Inc in six months (31st March until 30th September 2017) = $2,298,068 – $3,242,556 = -944,488 million
  • Cash burn of Snap Inc in one month = -944,488/6 = -157,415

The cash Burn Rate of Snap Inc is $157 million per month!

Importance

While looking at your burn rate, two things you should always keep in mind –

  • The burn rate broadly decides your sustainability. If the cash is burning more rapidly than the revenues, then your sustainability is at stake.
  • Secondly, the investors are always at a lookout for your start-up and how it has been performing. So, you need to take steps to take care of the burn rate to attract the right investors to your company.

This article has been the guide to what is Cash Burn Rate. Here, we explain the concept, its formula, how to calculate it, calculation example, importance, and types. You may learn other Corporate Finance Topics here –