Net Burn

What is net burn?

Net burn (net burn rate, net cash outflow) is the amount by which a company's liquid funds decrease in a month when new financing is left out of account. It results from all payments out less the payments in from the business, above all payments from customers. Inflows from capital increases, loans or convertible loans do not count as payments in. In simplified terms, net burn is the amount by which the business account stands lower at month end than at the start of the month once transfers from investors and banks are stripped out.

Net burn is the net figure within the burn rate, which also knows gross burn as the sum of all payments out. Runway is calculated from it, that is, the number of months the available funds will still last. It is therefore the focus when management, shareholders and investors discuss the timing of the next financing, cost programmes or the path to break-even. In investor reports and financing documents, it is usually shown monthly and as an average of several months.

Which payments go into net burn

Formula: net burn = payments out in a month - payments in from the business in the same month

A positive value means a cash outflow, a negative value a cash inflow. The following rules have become established for the delimitation in detail:

• Included are all payments from ongoing business activity, that is, customer payments, personnel, rent, purchasing and service providers, as well as capital expenditure, for example on hardware, equipment or purchased software.
• Not included are payments in from capital increases, convertible loans, bank loans or shareholder loans. They increase the cash balance but do not change the earning power of the business.
• Interest and repayment of ongoing financing are usually recorded as a payment out, because they actually reduce the available balance.
• VAT flows in with customer payments and is remitted to the tax office with a time lag through the VAT advance return, offset against the input VAT on the company's own incoming invoices. This timing difference creates fluctuations that have nothing to do with the course of business.

Because net burn is based on payments, it depends heavily on customers' payment behaviour. A large order that has not yet been paid in the month of invoicing lowers net burn only in the month the money arrives. Conversely, an annual prepayment lowers net burn sharply once, although the service is delivered over twelve months. Both affect working capital, that is, the capital tied up in ongoing business in receivables, inventories and open supplier invoices, and must remain recognisable in the analysis.

Use in the runway calculation

Formula: runway in months = freely available liquid funds divided by monthly net burn

Freely available are balances to which the company has unrestricted access. Pledged balances such as rent deposits or collateral deposited for bank guarantees (Avale) do not count. Unused credit lines such as an overdraft facility (a credit limit on the business account) are usually shown separately, because the bank can terminate them under certain conditions.

How reliable the runway is depends on which net burn is in the denominator. The average of the past is easy to determine but assumes that expenditure does not change. More reliable is the planned net burn from the monthly liquidity planning or the continuously updated forecast, which takes into account approved hires, expiring contracts and expected customer payments. If net burn is rising, the runway is shorter than the average suggests. If net burn is permanently negative, the company no longer consumes funds, and there is no runway in the proper sense.

One-off effects and adjusted net burn

Individual payments distort the monthly value because they do not recur. Typical one-off payments out are the transaction costs of a funding round, the costs of a legal dispute, severance payments, relocation costs or a back payment after a tax audit. Typical one-off payments in are tax refunds, the payout of grants or of a research allowance, and annual prepayments from customers.

For assessing the ongoing business, an adjusted net burn is therefore often formed, which strips out such items or, as with prepayments, spreads them over the months of performance. The adjustment is credible only if it is made openly: unadjusted and adjusted value side by side, each correction named and documented individually. Recurring items that are called "one-off" every year are not one-off effects. In due diligence, investors and buyers specifically check whether the adjustments follow this rule. They proceed similarly to adjusted EBITDA, earnings before interest, taxes, depreciation and amortisation corrected for special effects.

Difference between net burn and EBITDA

Net burn and EBITDA are often confused but measure different things. EBITDA is an earnings figure from the income statement. It follows accrual accounting: income and expenses are assigned to the period in which the service was performed, regardless of the time of payment. Net burn, by contrast, follows payments alone.

The differences are considerable in growth companies. Capital expenditure burdens net burn immediately but EBITDA not at all, because depreciation is recorded only below EBITDA. Rising receivables worsen net burn but not EBITDA. Prepayments from customers improve net burn before any revenue is reported. A company can therefore show a nearly balanced EBITDA and still consume considerable funds every month. For the question of when liquidity has to be refinanced, net burn is the right measure.

Worked example: calculating net burn and adjusting for one-off effects

A company with EUR 2.4 million of freely available liquid funds at quarter end reports the following figures for the quarter. In the second month, EUR 120,000 of advisory costs for a funding round arose as a one-off; in the third month, a customer paid EUR 210,000 in advance for twelve months.

• Month 1: payments out EUR 410,000, payments in EUR 260,000, net burn EUR 150,000.
• Month 2: payments out EUR 540,000, payments in EUR 260,000, net burn EUR 280,000.
• Month 3: payments out EUR 430,000, payments in EUR 470,000, net inflow EUR 40,000.
• Unadjusted average: (150,000 + 280,000 minus 40,000) divided by 3 = EUR 130,000.
• Adjustment for month 2: 280,000 minus 120,000 = EUR 160,000.
• Adjustment for month 3: The prepayment is, for simplicity, stripped out entirely, because nothing more flows in from this customer in the following months. Ongoing payments in 470,000 minus 210,000 = EUR 260,000, net burn 430,000 minus 260,000 = EUR 170,000.
• Adjusted average: (150,000 + 160,000 + 170,000) divided by 3 = EUR 160,000.
• Runway unadjusted: 2,400,000 divided by 130,000 = about 18.5 months.
• Runway adjusted: 2,400,000 divided by 160,000 = 15 months.
• Runway if the rise continues by EUR 10,000 a month: After ten months, 180,000 + 190,000 + … + 270,000 = EUR 2.25 million has been consumed. The remaining EUR 150,000 covers a good half of the eleventh month, so the funds last about 10.5 months.

The prepayment is already included in the cash balance; in the following eleven months, however, nothing more flows in from this customer. The adjusted value therefore describes the ongoing business more accurately. The trend also matters: adjusted net burn rises by EUR 10,000 from month to month. Depending on the method of calculation, runway therefore lies between about 10.5 and 18.5 months. As long as the rise is not explained, the trend value counts for planning. It is already below the 12 months that should be available at least when a funding process begins.

Distinction: net burn, gross burn, operating cash flow and free cash flow

• Gross burn: the sum of all payments out without deduction of payments in. It reflects the cost base; only after deducting payments in does the consumption of funds arise that net burn measures.
• Operating cash flow: the balance of payments from ongoing business activity, excluding capital expenditure and financing. Net burn additionally includes capital expenditure payments and, as a rule, interest and repayment of ongoing loans.
• Free cash flow: the cash surplus from the ongoing business after capital expenditure. A negative free cash flow corresponds essentially to a positive net burn. The term is used mainly in company valuation, usually for a year and before interest and repayment payments.

Common mistakes

• Counting financing inflows. If the inflow from a convertible loan is counted among payments in, net burn appears lower than the business warrants.
• Silently adjusting for one-off effects. An adjustment without disclosure is uncovered in the review and weakens confidence in all other figures.
• Treating prepayments as ongoing payments in. Annual prepayments lower net burn in the month of payment and raise it in the following months.
• Average instead of trend. A rising net burn is masked by an average over several months.
• Counting tied-up funds in runway. Pledged balances and deposits are not available for operations.

Frequently asked questions

How is net burn calculated?

Payments out in a month minus payments in from the business in the same month. With EUR 410,000 of payments out and EUR 260,000 of customer payments, it comes to EUR 150,000. Payments in from financing such as capital increases or loans are not deducted.

What does a negative net burn mean?

The company takes in more than it pays out, and its cash balance grows. If this continues, it is cash flow positive and no longer depends on new financing for ongoing operations.

May one-off effects be stripped out of net burn?

Yes, if the items are genuinely one-off and the adjustment is disclosed. It is customary to show the unadjusted and the adjusted value side by side.

How are net burn and burn multiple related?

The burn multiple divides the net burn of a period by the annual recurring revenue (ARR) added net in the same period. It shows how much liquidity is consumed per euro of new ARR. As a rule of thumb, values below 1 are considered very efficient, while values well above 2 are viewed critically.

Why does net burn differ from the loss in the income statement?

Because the income statement accrues by period and net burn measures payments. Depreciation, provisions, open receivables, prepayments and capital expenditure take effect in the two calculations at different times.

The Roemer Capital view

In the financial documents that Roemer Capital prepares for investors, net burn is always shown in two versions. The first shows it as it arose on the account, the second adjusted, with a reconciliation that names each correction individually. Investors usually check exactly this reconciliation before they work with the adjusted value.

For the runway calculation, Roemer Capital uses the planned net burn from the liquidity planning, not the average of the past. If the trend shows a rising net burn with flat payments in, Roemer Capital raises this with management before a process begins. The timetable of the round is decided by this development.