This might not be the most applicable title for a quick insight, but I thought the read would be more interesting with Disco Inferno playing in the back of your mind.
Burn rate. Think fuses. Think candles and bombs. You know how it works…If the wick runs out, one of two things happens. The fire reaches melted wax, at which time the flame writhes a bit and then is suddenly snuffed out. Or in the case of a bomb, it doesn’t go dark around you; you go dark. Think Wile E. Coyote and his inevitable self-defeat when faced with the Road Runner.
Not to start out the insight on a down note, (or a bang?) but I want to emphasize the critical importance in business of this little thing we call the burn rate. So what is it and why does it matter?
First, when you hear the term just know that it is often used in two different ways – both very different. Sometimes it will merely apply to the amount of a company’s expenses or total amount of operating costs incurred each month. This is the gross burn rate. If a company is generating revenue but losing money, the burn rate will sometimes refer to the amount of money the company is losing each month. This is the net burn rate. Both express how much cash the business is “burning” each month.
It’s important to distinguish between the two because ultimately they are used to determine an even more important datum measured not in dollars, but time. This critical piece of information is referred to as “runway”.
Let’s say a business is sitting on $28,000 in cash and is generating $6,000 in monthly revenue. Additionally, it has expenses totaling $10,000 each month. This is a net burn rate of $4,000. More importantly though, it has a runway of seven months. This is where you can think of runway as their proverbial wick.
Hopefully by now you’re grasping the importance of a company’s burn rate. When looking at any investment, it is vitally important to not only know it, but also understand it. If a business is generating sufficient cash each month for operations and seasonal cash needs, then runway is not really an issue. This company is generating enough capital to sustain a productive business.
But, if a company is in need of capital to “start-up” operations or grow the business, then runway will always be a factor. It is important when looking at any of these investments to be familiar with the net burn rate and the resulting runway.
To wrap things up, perhaps it would be good to return to the original examples and again highlight the importance of burn rate and this runway metric. In the first example, if the wick runs out, it goes dark. Literally. When you can’t pay your bills, the lights get turned out. The second example is a bit more extreme, but no less applicable. Bombs may not actually go off, but the aftermath of creditors descending on a business can certainly make it look like one did.