Nine out of ten start-ups fail. One of the biggest contributors to this number is Burn Rate.
There is no way to make it sound positive, but there are only 10% that succeed.
What did those 10% do differently, and how can one factor be this destructive?
Well, to put it simply, if you don’t look after your personal money and how you spend it,life gets very difficult. It’s no different with your business.
In this article, you’ll learn about what Burn Rate is and how to manage it.
What is Burn Rate, and why does it matter so much?
Before a fire can sustain itself, you have to feed it the necessary materials. The same goes for your business.
The Burn Rate describes the rate at which your money is spent before your business is able to generate profit on its own.
It’s important that you look at the Burn Rate on a monthly basis.
Burn Rate consists of two parts:
Gross Burn summarises the operating costs of your business alone.
This includes monthly overhead, payroll, rent, and taxes; the total amount of cash spent each month.
Net Burn, unlike Gross Burn, takes the revenue your business made over the last month into account as well as your operating costs.
To calculate net burn, subtract your revenue from your Gross Burn over a selected period.
This leaves you with how much money your business lost that month.
In the following example, you’ll see a breakdown of a Burn Rate calculation:
- Existing funds (Venture capital): €300,000
- Amount spent/ operating costs (Burn Rate): €150,000
- Revenue (Sales): €100,000 with a growth of 50%
This formula is used when calculating your Burn Rate.
Burn Rate = (Starting Balance – Ending Balance) / # Months
In this example, the Burn Rate matches with your sales after the first month. The business is generating profit after that.
However, most companies won’t get to the point where their business generates profit that quickly. Don’t be discouraged; sometimes profitability isn’t everything, as you can find out here.
How Do You Reduce Burn Rate?
Mishandling or not knowing your Burn Rate is the end for most start up businesses.
According to a study over 80% of young businesses close down after not finding enough capital to sustain their Burn Rate.
Why is that?
There are a lot of factors in your Burn Rate, some of which often get overlooked.
Here are some to keep in mind:
You are spending too much on branding
Getting your name out is a big part of success.
With social media, branding found a new avenue to get potential customers. Facebook, Instagram, TikTok, you can get your message out.
You can manage your social media yourself, or hire a marketing company to help you with your branding and online presence.
Buying ad space on Facebook, for example, starts in the low hundreds and has no ceiling. Be careful: know how much you’re spending and if you’re able to afford it – especially if you don’t have an immediate sales flow.
Focus on your core idea
Selling a lot of things is great. If you diversify, your customers can choose between different colours, sizes and programs. Sounds logical, right? It depends.
Let’s say you have a clothing business that started with a simple red scarf. Sales are steady, the Burn Rate is known and manageable, until other colours and designs come in. Suddenly, new costs arise.
Your production line had to be updated to operate the new designs some customers wanted. After a few weeks, there’s another idea and you lose what the red scarf did for you. While losing sight of what performed well, the need to branch out took over, and, subsequently, your Burn Rate grew.
Cut what’s not selling anymore. Make room for what works!
Your location matters
Where are you located, how are prices in the area, and is the space you’re renting too big for your needs?
A lot of start-ups started out of garages. Things were simple then. With time, the garage became too small to keep up with the demand. When and how to expand to a larger facility is one of the biggest sources for losing control of your Burn Rate.
If you change your location to something bigger too fast, and you can’t cover the new cost with your current sales, your Burn Rate increases. Expanding too late can hurt your business. Depending on your other costs, not finding the right time to grow as a business can hinder your progress, and in the worst case, trigger the Burn Rate to get out of control.
Pricing your products right
Are your products priced according to their production cost?
In this cost you need to consider:
- The type of material you use
- The tools to produce your product
- The skill level required to operate said tools
- The time needed to complete the product
Finding similar products that sell for less should be on your radar, as it helps your business to be competitive and ideally more profitable, which will lower your Burn Rate down the road.
Managing your inventory
Having enough inventory is an important thing to keep track of. There are different aspects to managing the right amount of finished products.
First, the more products that sit finished in storage, the more space you need. This increases your need to expand, which will increase the Burn Rate.
Also, if you are producing food products for example, you need to keep track of shelf life , because after they pass their sell-by date, you’ll need to destroy parts of your inventory.
On the other hand, sudden demand can be a pitfall, as well. For example, one viral video of your product can increase sales astronomically.
With insufficient inventory or the capacity to produce fast enough, there’s the chance you could lose customers.
Outsourcing, saving money at a cost
Labour is expensive depending on where you live.
If you look at giants like Apple or Nike, you’ll find that they’ve moved their production line to places like China. The reason being is that workers’ wages are low.
With low wages, you can increase profit and minimise your Burn Rate.
However, there are some major downsides to outsourcing.
- Quality control. The ability to observe and manage your own production line can suffer when you don’t have the chance to be on site. A simple mistake in translation, for example, can ruin a whole batch of finished products.
- Exploitation of local workers. There is a reason why prices are cheaper overseas. With no minimum wage laws, no unions that fight for thier rights, people can be exploited. This can be in working conditions, working hours, or pay, which is not enough to live on.
Loans can be a dangerous lifeline
Getting started is difficult if you don’t have proper funds to back you up. Not knowing what you need and how you’re able to pay it back is another pitfall that will increase your Burn Rate. Banks, like any other institution, are there to make money.
Interest changes in relation to:
- The world market
- The amount of money you want to borrow
- Your country
- Your ability to pay it back (given you’re profitable)
Unlike your own venture capital, a loan sticks with you, regardless of whether your business succeeds or goes bankrupt.
How Long Do You Anticipate Your Burn Rate Will Be?
Keeping a book of expenses is necessary for any entrepreneur.
Ideally, you can hire an accountant down the road that keeps track of any money going in or out. However, having the skills for bookkeeping can be a humbling experience. The meaning of money gets a new value in your life and in your business because of it.
Knowing exactly how much money is available, while overlooking your costs and your Burn Rate, can make money more than just a necessity to keep in check.
Every number in this book is connected to your dream, the time you invest in getting your business started. With this mindset, you can avoid making rash decisions that can hurt your capital.
Don’t think too big without having the data to back it up. Going all-in is a way to make the highest profit in a short period of time. At the same time, it also puts you on the fastest track to closing your doors.
Look for businesses that make similar products. Find out what their best practices are. Check for businesses that went under.
Was it simply mishandling their Burn Rate? This helps you find the dos and don’ts on a realistic scale and helps you anticipate how long your Burn Rate will last.
Knowing your Burn Rate is key for a successful business. Recognize areas that work, while improving those that increase your Burn Rate. Plan for the future with realistic expectations in regard to growth, without ignoring the downside to expanding too fast. Remember to check your numbers first, before acting. With this in mind, you can the Burn Rate for your business under control.