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.
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.
Why knowing Cash Burn Rate is Important?
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.
Cash Burn Rate Calculation
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.
The Relevance of Revenues in Cash Burn
How would you understand whether the cash burn rate is low or high?
There comes the relevance of revenues. Once you calculate the cash burn rate, you need to look at your sales.
Are your sales more than your burn rate? In our example, the sales of the start-up for the period should at least be $3000 or more. Otherwise, it isn’t a good position to be in.
Now, let’s take a practical example to calculate the cash burn rate and illustrate this.
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!
A significant amount of money raised by Snap Inc was invested in Marketable Securities.
Let us look at Snap’s Cash Position as of March 31, 2017
- Cash Position of Snap Inc (March, 2017) = Cash and Cash EquivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. (March, 2017) + Marketable Securities (March, 2017).
- Cash Position of Snap Inc = $1,427,114 + $1,815,442 = $3,242,556
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. 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
- 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!
This article has been the guide to Cash Burn Rate, cash burn rate calculation, and examples. You may learn other Corporate Finance Topics here –
- Negative Cash Flow
- Examples of Cash Book
- Negative Interest Rate – Meaning
- Discount Rate vs. Interest Rate
- Range Formula