Startups in the SaaS world often find themselves pouring resources into growth before seeing significant returns. To stay afloat, understanding and managing your burn rate is crucial. This metric reveals how quickly your company is consuming cash. In this article, we'll break down the burn rate, showing you how to calculate gross and net figures. Discover why the burn rate is an essential KPI for SaaS businesses and learn how to leverage it for optimal financial management.
What is the Burn Rate?
The startup phase is often synonymous with significant expenses. For SaaS companies, finding a balance between growth and profitability is crucial. The burn rate is a key financial indicator that measures the speed at which a company consumes its cash.
Definition of burn rate
The burn rate is a crucial financial metric for startups, particularly those in the SaaS sector. It measures the rate at which a company's cash balance decreases over time, considering both expenses and revenue.
Why is the burn rate important?
The burn rate is a crucial financial metric for any company, especially startups, as it directly impacts strategic decision-making and long-term viability.
- Forecasting Lifespan: The burn rate helps estimate how long a company can sustain its operations with its current cash reserves before it needs to raise additional funds. This forecast is vital for planning and ensuring that the company does not run out of cash unexpectedly.
- Optimizing Expenses: By analyzing the burn rate, startups can identify which cost items consume the most resources. This insight allows them to make informed decisions on where to cut costs, improve efficiency, and allocate resources more effectively, thereby extending their financial runway.
- Negotiating with Investors: The burn rate is a key indicator that investors use to assess a company’s financial health and operational efficiency. A well-managed burn rate can strengthen a company’s position during funding negotiations, demonstrating prudent financial management and a clear path to sustainability.
Difference between gross burn rate and net burn rate
The gross burn rate solely measures the sum of an enterprise's expenses and disbursements (excluding exceptional, non-recurring expenses). The goal is to track the average amount of cash consumed by purchases, overhead, salaries, etc.
The net burn rate corresponds to the period's average payments minus receipts. Therefore, it takes into account revenue generated from sales. As with the gross burn rate, it excludes non-recurring incoming cash flows, such as cash from a fundraising round.
Complementing burn rate with cash runway
While the burn rate provides insight into your company’s gross and net cash consumption, the cash runway is a critical complementary metric. It assesses how long your current cash reserves can sustain operations before being exhausted. This is particularly important for early-stage companies, where the burn rate is often analyzed in conjunction with the cash runway to determine the number of months the business can operate without increasing its revenue. By understanding your cash runway, you can accurately plan the timing of future fundraising efforts, ensuring the company remains financially viable.
How to precisely calculate burn rate: methods and examples
There are two main methods to determine the level of cash burn: the gross burn rate and the net burn rate. Let's examine these two indicators with a concrete example.
Example of gross burn rate calculation
Cash burn is a relatively simple financial metric to manage, unlike other SaaS KPIs. It relies solely on known historical data from the company’s accounting or bank accounts. Of course, this indicator fluctuates over time, especially depending on the growth phase reached. This means that the ratio needs to be updated regularly.
A SaaS company has the following expenses and revenues over the last three months:
Let’s start by determining the gross burn rate, which is the average monthly expenses, excluding any exceptional amounts where applicable. In our example, all of the company’s quarterly disbursements are recurring for its operations. Thus, the gross burn rate for this company is €32,400/3 months = €10,800.
Gross burn rate formula
Gross Burn Rate = Number of Months in the Period - Total Cash Outflows
This formula calculates the monthly cash consumption, excluding any one-time or exceptional expenses.
Example of net burn rate calculation
Using the previous data, let’s now calculate the average monthly revenues, excluding exceptional and non-recurring inflows, such as:
- Fundraising of €500,000
- Operating grant of €120,000
The average recurring revenues are calculated as (622,940 - 500,000 - 120,000)/3 months = €980. This amount is then deducted from the average operating expenses, which was previously calculated as the gross burn rate of €10,800. Therefore, the net cash burn rate is €10,800 - €980 = €9,820.
Net burn rate formula
Net Burn Rate = Gross Burn Rate−Number of Months in the Period - Total Recurring Revenue
The net burn rate offers a more accurate picture of a company's cash consumption by accounting for recurring revenue. Unlike the gross burn rate, which only considers expenses, the net burn rate subtracts average monthly revenue from total expenditures, revealing the actual rate at which cash is depleted.
Example of Cash Runway
In this example, the SaaS company’s cash balance is €593,540.
This KPI measures the time the company has before running out of cash. With an average net monthly disbursement of €9,820, the company can last for 593,540/9,820 = 60.4 months, or 5 years. This assumes that costs and revenues remain constant, rarely occurring when the business grows. Therefore, it is crucial to update this indicator regularly.
Cash runway formula
Implied Runway = Burn Rate - Cash Balance
This KPI is calculated by dividing the cash balance by the burn rate.
Why burn rate matters: the impact on SaaS and Startups
Any young SaaS company must make investment expenditures (especially in R&D) before developing and marketing its product. Even if it raises funds, it must closely monitor its cash flow. The burn rate is an excellent tool for optimized cash management.
Understanding the company’s longevity with its cash reserves
The burn rate allows managers to calculate the cash runway, determining how long their cash reserves will allow them to operate without raising new funds. This estimation is essential for good cash management, especially when a fundraising round can take between 6 and 18 months. Anticipating financial needs then becomes crucial.
Tracking burn rate evolution to measure performance
By analyzing the net burn rate and breaking down cash inflows and outflows, a SaaS company gains additional tools to refine its decisions. Regular monitoring of this KPI allows for measuring the evolution of activity, business volume, and profitability. If the gross burn rate increases without corresponding revenue growth, the company needs to question the efficiency of its spending.
Ultimately, the burn rate is crucial for managing the cash flow of a startup or SaaS company. Including it in your dashboard is essential. Fincome empowers you to track this vital metric through a seamlessly integrated platform, enabling you to focus on strategic analysis, corrective actions, and driving business growth.
