New businesses will often not be profitable in their early stages and will require cash to keep going. The rate at which the cash is used by the business is referred to as the burn rate, it is a measure of negative cash flow, and is typically quoted as a monthly burn rate.
Cash Burn Rate Calculation
Burn rate can be calculated in one of two ways. If historical cash balances are available, find the change in the cash balance over a number of months and divide the figure by the number of months.
For example, If the beginning cash balance is 1,000,000 and 4 months later the cash balance is 60,000, then the cash burn rate is given as follows.
Cash burn = (Ending cash balance - Beginning cash balance) / Number of months Cash burn = (1,000,000 - 650,000) / 4 = 87,500 per month.
Burn Rate Formula
An alternative method of calculating the rate is to estimate the cash flow over a given period of months and then divide by the number of months.
In the formula the cash flows referred to are defined as follows.
Cash flows from operating activities are cash flows which are generated by the main revenue producing activities of the business, usually cash receipts from the trading operations such as the sale of goods and services.
Cash flows from investing activities are normally related to the purchase of long term assets such as plant, equipment, and machinery.
Both the cash flow for operating activities and the cash flow from investing activities can be obtained from the cash flow statement in our Financial Projections Template.
Burn Rate Formula Example
As an example suppose a business had losses before depreciation of 240,000 for 6 months, and during that time needed a further 100,000 to fund working capital requirements, and 200,000 for capital items, then the total negative cash flow would be 540,000. The monthly cash burn rate would be calculated as follows.
Operating cash flow = -240,000 - 100,000 = -340,000 Investing cash flow = -200,000 Cash burn = Cash flow from operating and investing activities / Number of months Cash burn = (350,000 + 200,000) / 6 = 90,000
Because this calculation uses operating losses it takes into account any revenue generated. In a high tech start up the revenue is usually zero and in effect the operating losses are simply the operating costs for the period.
Cash Out Date
The cash out date is the period of time it will take for the business to run out of cash based on its available cash balances and the cash burn rate. The cash out date is sometimes referred to as the cash zero date or the time out of cash date.
The cash out date is calculated using the following formula.
If the cash burn-rate is 50,000 per month and the cash available is 350,000 then the cash out date is given as follows.
Cash out date = Cash available / Burn rate Cash out date = 350,000/ 50,000= 7 months
This shows that at the current rate the business will run out of cash in 7 months. A business needs to monitor the cash out date to ensure that it is never shorter than the time it takes to raise additional funding.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.