Cash Burn Rate

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Why is cash important for a business?

Cash is the lifeblood of a company, so knowing where you stand is important. A firm may be profitable (on paper or even actually), but without sufficient liquidity it will still run into trouble. Therefore, companies should always keep an eye on their cash burn rate.

What is the Cash Burn Rate? Definition

The Cash Burn Rate (CBR), also called "Cash Burn (CB)", is simply the rate at which a company uses up its cash reserves or cash, when it is not making more money than it spends. Essentially, CBR is a measure of (negative) cash flow. You typically check the CBR monthly or quarterly. For example, if your CBR was €100.000, your company spent €100.000 in the given month or quarter.

The Cash Burn Rate became a popular metric during the dot-com era to assess how quickly start-up or Internet companies are using up their cash reserves.

Why is knowing the Cash Burn Rate important? Relevance

With the CBR you calculate how fast a company uses its cash reserves and you can see how fast its liquidity is moving in a positive or negative direction. You also gain insight into building a healthy balance on your cash flow and how long it will take before you run out of liquid assets.

The CBR is particularly important for start-up companies and other businesses in their early stages. Often, start-ups can take years to become profitable, especially in fast-growing tech markets, so they need to keep a close eye on their cash situation and carefully monitor their spending.

How do you calculate the Cash Burn? Formula

Note that there is no official standard for calculating CBR. It can depend on the company and industry sector.

The cash burn rate can be calculated in one of two ways:

1. USING THE CASH FLOW STATEMENT: This first, simple calculation method is based on the cash flow statement and takes the cash used for operations plus cash used for capital expenditures and purchases of ongoing businesses (net of cash received) and divides it by the number of months covered by the cash flow statement (i.e. 12 months for annual and 3 months for quarterly statements).
   

   Here's a simplified example of this way of Cash Burn Rate Calculation:

   Let's say you want to know a firm's CB during the first 3 months (January to March). You first check their balance on the 1st of January.

   Suppose on January 1st, their cash balance was €30.000 and at the end of the period (March 31st), their balance was €20.000.

   That means that during these three months they burned an amount of €30.000 - €20.000 = €10.000 in cash.

   You now divide the difference between the opening balance and the closing balance by the number of months. In the above example, it concerns 3 months and the difference is €10.000.

   That means the CBR or CB is €10.000 / 3 = €3.333.

   Note that in reality, CBR may have to be adjusted for any changes to cash as a result of: borrowings and repayments of borrowings, proceeds from the sale of equity and the exercise of stock options or warrants, paid-in-capital and minority interest, and capital expenditures financed under a capital lease, etc.

2. USING THE INCOME STATEMENT: This second, more complex calculation method is based on the income statement and divides the earnings before interest, taxes, depreciation and amortization (EBITDA) excluding non-recurring gains and losses by the number of months covered by the income statement.

Months to Burnout

The related measure of "Months to Burnout" can provide an estimate of how much longer a company can survive without a capital increase (via debt or equity financing) and is calculated as follows:

Months to Burnout = (Cash + Cash Equivalents + Short-term Marketable Securities) / Cash Burn Rate.

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