Typically, startups go through a long period of spending before they have cash flow comes in from revenue. If you want to ensure the long-term financial viability of your startup, it’s best not to burn your cash. That’s what the burn rate indicator is all about. Find out in this article what it is and how to calculate both gross and net burn rate. We also explain why burn rate is one of the essential KPIs your SaaS should be reporting , and how you can use it to optimize your business management.
1 - What is burn rate?
Startups have to spend time developing their product before they can cash in on sales. This is the classic situation for a startup, especially a SaaS startup. However, they need to regularly calculate their burn rate, that is, how quickly their money is running out. Otherwise the adventure may come to an abrupt halt.
1.1 - Burn rate definition
“Burn rate” simply means “cash consumption”. This indicator measures the amount of money a SaaS or startup burns over a given period. It is generally analyzed on a month-by-month basis.
1.2 - Difference between gross burn rate and net burn rate
The gross burn rate measures only the sum of the company’s expenses (excluding non-recurring, one-off expenses). The aim is to monitor the average amount of cash consumed by purchases, overheads, salaries, etc.
Net burn rate corresponds to average payments for the period, minus receipts. It therefore takes into account revenue from sales. As with the gross burn rate, it excludes non-recurring financial inflows such as cash from fundraising.
1.3 - Burn rate and the cash runway
The burn rate gives you a precise view of your gross and net cash consumption. The indicator that complements it perfectly is the cash runway. This KPI corresponds to the number of months of available cash before you run out of money. It is obtained by dividing the cash balance by the burn rate. It therefore shows how long the startup can last without increasing the rate of its revenues, and provides a timetable for any fundraising.
2 - How to calculate burn rate?
Ultimately, there are 2 ways of determining burn rate: the gross burn rate and the net burn rate. Let’s look at how these two indicators are calculated, using a concrete SaaS example.
2.1 - A simple KPI calculation based solely on the company’s history
Unlike other SaaS KPIs, cash burn is a simple piece of financial information to master. It corresponds solely to known, historical data, taken from the company’s accounting records or bank accounts. Of course, this indicator fluctuates over time, especially as a company grows. This implies regular updating of the ratio.
2.2 - Example of gross burn rate calculation
Over the past 3 months, a SaaS has reported the following revenues and expenses:
Let’s start by determining the gross burn rate, i.e. the average monthly expenses, excluding any one-off amounts. In our example, all the company’s quarterly expenses are recurring. The company’s gross burn rate is therefore 32,400 euros/3 months = 10,800 euros.
2.3 - Net burn rate calculation
Using the previous example, let’s now determine average revenues per month without taking into account one-off and non-recurring cash receipts, in this case:
• fundraising for 500,000 euros;
• operating subsidy of 120,000 euros.
Thus, average current revenues are (622,940 - 500,000 - 120,000)/3 months = 980 euros. This sum is deducted from average operating expenses, i.e. the gross burn rate of 10,800 euros calculated above. Net cash burn is therefore (10,800 - 980) = 9,820 euros.
2.4 - Cash runway
With this example, the SaaS cash balance amounts to 593,540 euros.
With a net cash burn rate per month of 9,820 euros, the company can last 593,540/9,820 = 60.4 months, or 5 years. This assumes that costs and revenues remain constant. This is rarely the case when the business is in a growth phase. It is therefore vital to update this indicator regularly.
3 - Why should SaaS companies calculate burn rate?
Any young SaaS company needs to make capital investments (R&D in particular), before developing its product and bringing it to market. Even if it is raising funds, it needs to watch its cash flow very closely. The burn rate is an excellent tool for optimized cash management.
3.1 - Knowing how long a company can last on its cash flow
With this indicator, SaaS managers can deduce their cash runway and know how many months they can survive without seeking new financing. This is an essential first step in good cash flow management. Given that fundraising takes between 6 and 18 months, it’s important to anticipate the company’s needs.
3.2 - Analyze burn rate trends to measure progress or deterioration
By working with the net burn rate and its breakdown between cash receipts and cash expenses, the SaaS has more granular data and actionable solutions at its disposal. Tracking this KPI over time also makes it possible to measure how the company’s business volume and profitability are evolving. If gross cash burn increases without generating more revenue, the company needs to question the effectiveness of its spending.
The burn rate is therefore a key indicator for managing SaaS cash flow. It’s one of the KPIs you absolutely must monitor in your dashboard. Fincome helps you monitor your indicators through out platform that directly links to your applications. You can then concentrate on analyzing the figures, taking corrective action, and driving growth. Request an online demo and see how you can use our solutions to calculate burn rate and other KPIs.
💡 Complete your reading with the following articles:
• 3 common mistakes that kill SaaS startups
• All you need to know to calculate monthly recurring revenue
• Automated reporting for SaaS: a quick guide
• KPI reporting at every stage of your startup
• Annual recurring revenue: what it is and how it’s calculated
• How to calculate LTV and track your SaaS performance
• Why is SaaS financial reporting still crucial for your startup in 2023?
