Burn Rate

What is the burn rate?

Burn rate (monthly cash consumption, also cash burn) refers to the amount of liquid funds, that is, bank balances and cash, that flows out of a company in a month. Two versions are distinguished: gross burn as the sum of all payments out and net burn as payments out less receipts from the business, above all payments from customers. Money from investors and lenders counts as a receipt in neither version. A water tank gives a clear picture: gross burn measures the outflow, net burn how far the level falls after the inflow is deducted.

The metric is needed above all in growth companies that deliberately spend more than they take in and cover the difference with equity from investors. It appears in monthly reporting to shareholders and the advisory board, in the financial model, in investor meetings and in financial due diligence, the review of the financial figures by investors or buyers before the contract is concluded. Together with the stock of liquid funds, net burn determines the runway, that is, the number of months until the available funds are used up.

Gross burn and net burn

Gross burn (Brutto-Burn)

Gross burn comprises all payments out in a month: salaries including wage tax and social security contributions, rent, software and infrastructure, marketing, external service providers, investment in equipment and servicing of loans. It shows the cost base the company bears regardless of its revenue and that the management steers directly through hiring and spending.

Net burn (Netto-Burn)

Net burn deducts from gross burn the receipts from the business. It shows by how much the stock of liquid funds actually falls and is therefore the figure with which the runway is calculated. If net burn is negative, more flows in than out; the company is then cash flow positive.

Anyone who speaks of “burn” in practice usually means net burn. For analysis, both figures are needed: a falling net burn can be due to growing revenue or to reduced spending. Only gross burn shows which cause applies.

Formula: Gross burn = sum of all payments out in a month; net burn = gross burn minus receipts from the business, excluding inflows from investors and lenders

Calculating burn rate: payments instead of expenses

The burn rate is a liquidity figure, not an earnings figure. It measures payments, not expenses and income. Several differences from the income statement (profit and loss account) follow:

• Depreciation spreads the acquisition cost of, for example, a server or office equipment over the years of use. It reduces earnings but leads to no payment out and is left out. The acquisition itself, by contrast, counts in full in the month of payment.
• Provisions are amounts formed in the balance sheet for obligations whose amount or due date is still open, for example for untaken leave. They reduce earnings immediately, the burn rate only when payment is made.
• Receivables from invoices that customers have not yet settled increase revenue but not yet receipts.
• Financing inflows from capital increases, convertible loans or loans are not included in the burn rate. They extend the runway but do not come from the business.

Because individual months fluctuate strongly, the burn rate is often stated as the average of the last three months. Fluctuations arise from annually due insurance and licences, quarterly advance tax payments, bonus payments, VAT payments and larger one-off orders. An average is meaningful only if such items remain identifiable.

Burn rate in planning and steering

Looking back, the burn rate describes what has happened. For decisions, the planned burn rate of the coming months counts. It results from liquidity planning, which projects all expected receipts and payments month by month, and from the financial model, which maps this planning over several years in scenarios. In the current financial year, it is updated through the forecast, a projection from the actual values so far and the current expectation for the remaining months. In technology companies, personnel often accounts for the largest part of gross burn. The hiring plan is therefore the most important lever of the future burn rate.

Shareholders' agreements often make the annual budget subject to the approval of the investors or an advisory board and require reports on variances. Irrespective of this, the German Restructuring Act (Unternehmensstabilisierungs- und -restrukturierungsgesetz, StaRUG), Section 1(1), obliges the management to monitor continuously developments that could endanger the continued existence of the company. A burn rate regularly reconciled against the plan evidently belongs here.

The burn rate is steered through earlier receipts (shorter payment terms, advance payment, consistent receivables management), later payments (negotiated supplier terms) and a lower cost base. Cost reductions have the strongest effect but, because of notice periods, usually only after a few months.

Burn multiple as an efficiency measure

A high burn rate is in itself neither good nor bad. What matters is the growth it generates. The burn multiple answers this question. It relates cash consumption to the increase in annual recurring revenue (ARR).

Formula: Burn multiple = net burn for a period divided by net new ARR in the same period

Net new means: revenue from new customers and additional revenue from existing customers less cancellations and downgrades. A burn multiple of 1 means that one euro of liquidity was consumed for every euro of additional ARR. As a rule of thumb, a value below 1 is considered very efficient and a value up to about 2 acceptable; significantly higher values are as a rule questioned critically. With long sales cycles or high upfront investment in product development, temporarily higher values are common. The burn multiple complements metrics such as the Rule of 40 (revenue growth plus profit margin in percent, target at least 40) and the payback period of customer acquisition costs, but does not replace them.

Burn rate in the funding round and due diligence

In a funding round, the burn rate determines two things: the point in time at which a process must begin and the size of the round. Investors ask about gross and net burn, about the development over the last twelve months and about the planned burn rate after the round. The planned use of proceeds in the pitch deck, that is, the allocation of the new capital to personnel, sales and product, should be derivable from these figures. It is common to size a round so that it provides 18 to 24 months of runway at the planned burn.

In due diligence, reviewers reconcile the reported burn rate against bank statements, the trial balance (overview of all bookkeeping accounts) and the monthly management accounts (BWA, betriebswirtschaftliche Auswertungen). Typical review questions are whether outstanding payments to suppliers keep the burn artificially low, whether one-off effects have been stripped out and whether the planned increase after the round is reflected in the headcount plan. Large deviations between earlier plan and actuals weaken the credibility of the entire plan.

Worked example: calculating burn rate, runway and burn multiple

A software company reports the following average payments for the last three months: personnel EUR 330,000, rent and IT EUR 60,000, marketing EUR 90,000. Receipts from customers average EUR 290,000 per month. Liquid funds amount to EUR 3.42 million. ARR rose by a net EUR 600,000 in the past quarter.

• Gross burn: 330,000 + 60,000 + 90,000 = EUR 480,000 per month.
• Net burn: 480,000 minus 290,000 = EUR 190,000 per month.
• Runway: 3,420,000 divided by 190,000 = 18 months.
• Net burn in the quarter: 3 × 190,000 = EUR 570,000.
• Burn multiple: 570,000 divided by 600,000 = 0.95.
• Planned hires raise gross burn by EUR 60,000 to EUR 540,000. With unchanged receipts, net burn rises to EUR 250,000.
• Runway after the hires: 3,420,000 divided by 250,000 = around 13.7 months.

The burn multiple of 0.95 shows efficient growth: for every euro of new ARR, less than one euro of liquidity was consumed. The hires, however, shorten the runway by more than four months unless receipts rise at the same time. At 13.7 months, it is still within the range of 12 to 18 months that should be available when a funding process begins. Whether the hires are justified depends on when the new employees generate additional revenue. This assumption belongs in the liquidity planning and is questioned by investors in the review.

Distinction: burn rate, net burn, runway and operating cash flow

• Net burn: the net figure of the burn rate and the basis of the runway calculation. The separate entry deals with adjustment for one-off effects.
• Runway: the time figure that results from liquid funds and net burn. Net burn is its denominator.
• Operating cash flow: the balance of payments from ongoing business activity according to the cash flow statement, excluding investments and debt service. Without investments and loans, net burn essentially corresponds to a negative operating cash flow.
• Default alive: the question of whether a company, on its current trajectory, reaches break-even before the funds are used up. The burn rate is an input for this.

Common mistakes

• Earnings instead of payments. Anyone who derives the burn rate from the income statement overlooks investments, receivables and payment terms and obtains a figure that is too optimistic.
• Stating only one figure. A net burn without gross burn conceals whether revenue growth or cost cutting is responsible for the decline.
• Looking back instead of planning. The runway is calculated with the burn of the past even though hires that raise it have already been decided.
• No efficiency view. A low burn rate without growth convinces investors as little as high growth with a burn multiple well above 2.

Frequently asked questions

What is the difference between gross burn and net burn?

Gross burn comprises all payments out in a month and shows the cost base. Net burn deducts the receipts from the business and shows how much the liquid funds actually fall.

How is the burn rate calculated?

Gross burn is the sum of all payments out in a month; net burn is these payments out less the receipts from the business. The calculation uses actual payments, usually as an average of the last three months. The basis is account movements or a directly prepared liquidity calculation, not the expenses in the income statement.

What is a good burn rate?

There is no generally good amount. It is acceptable if the runway covers the next funding process with a buffer and growth supports the consumption. As a rule of thumb, a burn multiple of around 1 is considered good; a high burn with stagnating revenue, by contrast, is a warning sign.

How often should the burn rate be determined?

Monthly as a metric in reporting, and the account balance additionally weekly. In phases of tight liquidity, a weekly liquidity forecast is usual.

The Roemer Capital view

Before the first investor contact, we reconstruct gross and net burn for the last twelve months from the account movements and reconcile them with the reporting. Deviations are thus clarified before they become a question in due diligence.

We derive the timetable from the planned burn rate. In our experience, a funding round takes 6 to 8 months; 12 to 18 months of runway should therefore be available when the process begins. In fractional CFO engagements, we build burn rate and burn multiple firmly into the monthly reporting to the shareholders.