Net burn

What Is Net Burn?

Net burn is a critical financial metric, particularly within startup finance, representing the rate at which a company depletes its cash reserves after accounting for any revenue generated⁸⁴, ⁸⁵. It offers a comprehensive view of a company's financial health by showing the actual cash loss each month, making it a key indicator for entrepreneurs, founders, and investors⁸², ⁸³. Essentially, net burn is the negative cash flow from operations⁸⁰, ⁸¹.

History and Origin

The concept of "burn rate," including net burn, emerged prominently with the rise of technology and venture-backed companies, particularly during the dot-com boom of the late 1990s and early 2000s. As many nascent companies prioritized rapid growth and market capture over immediate profitability, they relied heavily on external capital, such as venture capital, to cover their significant operating expenses⁷⁹. Investors needed a clear way to assess how long these companies could survive without additional financing, leading to the adoption of burn rate metrics. Early venture capitalists and financial commentators, like Fred Wilson and Mark Suster, frequently discussed and popularized the importance of understanding burn rates for both founders and investors navigating these high-growth, often unprofitable, phases of a company's lifecycle.⁷⁷, ⁷⁸.

Key Takeaways

• Net burn quantifies the actual monthly cash loss a company incurs after all income and expenses are considered⁷⁵, ⁷⁶.
• It is a crucial financial metric for startups and early-stage companies to forecast their financial needs and calculate their runway⁷³, ⁷⁴.
• A negative net burn indicates that a company is profitable and generating cash rather than depleting it⁷¹, ⁷².
• While a high net burn might be a strategic choice for aggressive growth, it must be carefully monitored to ensure sustainability and avoid premature cash depletion⁶⁹, ⁷⁰.

Formula and Calculation

The net burn is calculated by subtracting a company's total revenue from its total operating expenses over a specific period, typically monthly⁶⁷, ⁶⁸.

The primary formula is:

$\text{Net Burn} = \text{Total Monthly Operating Expenses} - \text{Total Monthly Revenue}$⁶⁶

Alternatively, especially when considering more granular financial statements, some calculations might also account for cost of goods sold:

$\text{Net Burn} = (\text{Monthly Revenue} - \text{Cost of Goods Sold}) - \text{Gross Burn Rate}$

Or, by looking at the change in cash balances:

$\text{Net Burn} = \frac{\text{Beginning Cash Balance} - \text{Ending Cash Balance}}{\text{Time Periods During Measurement}}$⁶⁴, ⁶⁵

Interpreting the Net Burn

Interpreting net burn requires context, as there is no single "good" or "bad" rate universally applicable to all companies⁶², ⁶³. For a startup, net burn is primarily used to determine its "runway" – the number of months it can continue operating before exhausting its cash reserves without additional funding. ⁶⁰, ⁶¹For instance, if a company has $1,000,000 in cash and a net burn of $50,000 per month, its runway is 20 months ($1,000,000 / $50,000).
⁵⁹
A high net burn can be acceptable, or even strategic, for companies in early growth stages that are aggressively investing in product development, market expansion, or customer acquisition. ⁵⁷, ⁵⁸In these scenarios, investors might expect a higher burn in exchange for rapid growth and market share. ⁵⁶Conversely, a consistently high net burn without corresponding growth or a clear path to profitability can signal inefficiency or an unsustainable business model. ⁵⁴, ⁵⁵Businesses in a downturn may shift their focus from aggressive growth to operational efficiency, making a controlled net burn even more critical.
⁵², ⁵³

Hypothetical Example

Consider "InnovateTech," a burgeoning software-as-a-service (SaaS) startup. In a given month, InnovateTech records $75,000 in revenue from its subscription services. However, its total operating expenses for the same month amount to $120,000, covering salaries, office rent, software licenses, and marketing.

To calculate InnovateTech's net burn:

$\text{Net Burn} = \text{Total Monthly Operating Expenses} - \text{Total Monthly Revenue}$
$\text{Net Burn} = \$120,000 - \$75,000$
$\text{Net Burn} = \$45,000$

This means InnovateTech's net burn for the month is $45,000. If InnovateTech currently holds $540,000 in its cash reserves, its remaining runway would be:

$\text{Runway (Months)} = \frac{\text{Cash Reserves}}{\text{Net Burn}}$
$\text{Runway (Months)} = \frac{\$540,000}{\$45,000}$
$\text{Runway (Months)} = 12 \text{ months}$

InnovateTech has approximately 12 months before it needs to either achieve profitability or secure additional funding rounds.

Practical Applications

Net burn is a cornerstone metric in several financial contexts, particularly for startup management and investor relations.

1. Forecasting and Planning: Startups use net burn to project how long their existing cash reserves will last, thereby establishing their financial runway. ⁵⁰, ⁵¹This insight is critical for strategic planning, including decisions on hiring, product development, and future funding rounds.
   ⁴⁹2. Investor Assessment: Venture capital firms and angel investors closely scrutinize a company's net burn rate to gauge its financial discipline and sustainability. ⁴⁸A high burn rate might signal a need for frequent fundraising, potentially diluting existing equity. ⁴⁷Conversely, a well-managed net burn can instill confidence in investors, potentially leading to more favorable terms during capital raises.
   ⁴⁵, ⁴⁶3. Operational Efficiency Analysis: Tracking net burn allows management to assess operational efficiency and identify areas where expenses might be too high relative to revenue. ⁴³, ⁴⁴This helps in making informed decisions about resource allocation and cost control.
   ⁴²4. Valuation and Investment Strategy: Investors incorporate net burn into their overall assessment of a company's valuation. ⁴¹Companies with a history of high cash burn without corresponding growth may face difficulty raising new funds on favorable terms, potentially leading to reduced valuations. ⁴⁰Publicly traded companies, even those with substantial revenue, can be flagged as "cash-burning machines" if their operations are not self-sustaining and rely on continuous outside funding.
   ³⁹

Limitations and Criticisms

While net burn is a vital metric, it has several limitations and criticisms that warrant a balanced perspective.

1. Lack of Contextual Depth: Net burn provides a single number without immediately explaining the reasons behind it. ³⁸A high net burn might be a deliberate, strategic investment in growth, but without deeper analysis of the underlying cash flow components, it can be misinterpreted as poor efficiency. ³⁶, ³⁷For instance, significant one-time expenditures, such as large equipment purchases or annual software contracts, can temporarily inflate net burn, skewing monthly comparisons if not accounted for separately.
   ³⁵2. Variability in Revenue: Since net burn accounts for revenue, fluctuations in sales can lead to a volatile net burn rate, especially for businesses with seasonal income or unpredictable sales cycles. ³³, ³⁴A sudden dip in revenue, even with consistent operating expenses, can sharply increase net burn, creating a false impression of declining financial health.
   ³²3. Risk of Under-Investment: A strong focus on minimizing net burn can sometimes lead to under-investment in critical growth initiatives, such as research and development, marketing, or talent acquisition. ³¹This conservative approach, while extending the runway, could hinder a startup's ability to achieve necessary scale or compete effectively in dynamic markets.
   ³⁰4. Not a Standalone Metric: Net burn should not be evaluated in isolation. It needs to be analyzed in conjunction with other financial metrics like gross margin, customer acquisition cost (CAC), and overall revenue growth. ²⁸, ²⁹A high net burn might be a concern if growth metrics are stagnant, but less so if the company is achieving rapid, efficient expansion. ²⁷The Corporate Finance Institute emphasizes that investors often provide funding based on a company's burn rate because startups frequently operate without positive net income in their early stages.
   ²⁶

Net Burn vs. Gross Burn

Net burn and gross burn are two distinct but related concepts used to measure a company's cash consumption. The primary difference lies in how they account for incoming revenue.
²⁵
Gross Burn represents the total amount of cash a company spends over a specific period, typically monthly, without considering any income it generates. ²³, ²⁴It is simply the sum of all operating expenses and other cash outflows. ²¹, ²²Gross burn provides a straightforward measure of a company's total spending and its cost drivers, regardless of its sales performance. ²⁰It is useful for understanding the baseline expenditures required to keep the business running.
¹⁹
Net Burn, as discussed, is the amount of money a company loses each month after taking its revenue into account. ¹⁸It is calculated by subtracting monthly revenue from gross burn. ¹⁷Net burn offers a more realistic view of a company's actual cash deficit and how quickly its cash reserves are depleting. ¹⁶For investors, net burn is often the more critical figure as it directly impacts the company's runway—how long it can survive without additional capital. A ¹⁵negative net burn indicates that a company is cash flow positive and operating profitably.

W¹³, ¹⁴hile gross burn shows how much is spent, net burn reveals how much is lost. Both are important for a complete picture of a company's financial standing, especially for a startup.

#¹²# FAQs

How often should a company monitor its net burn?

It is advisable for startup companies to review their net burn rate on a monthly basis. Re¹¹gular monitoring helps ensure the company is aware of its financial health and can make timely adjustments to its spending or revenue generation strategies. Du¹⁰ring periods of rapid growth or significant changes, more frequent reviews, such as bi-weekly or weekly, might be beneficial.

#⁹## Can net burn be a positive number?
Yes, net burn is typically a positive number, indicating that a company is spending more cash than it is bringing in. Ho⁸wever, if a company is generating more revenue than its operating expenses, its net burn would be a negative number. A "negative net burn" signifies that the company is profitable and building its cash reserves.

#⁶, ⁷## Does a high net burn always mean a company is in trouble?
Not necessarily. A high net burn can be a deliberate part of a startup's growth strategy, especially if it's investing heavily in product development, market expansion, or customer acquisition. Ho⁴, ⁵wever, it is crucial that the company has a clear plan for achieving profitability or securing additional funding rounds before its cash reserves are depleted. In², ³vestors evaluate a high net burn in conjunction with growth metrics and the overall business model.¹