Burn Rate.

It just sounds nasty, and maybe in a sense, it is. But in reality, burn rate is actually just a colorful term for “negative cash flow.”

Number-crunching types have referred to burn rate for years, but the term didn’t really catch fire (sorry!) and become part of the normal business vocabulary until the dot-com frenzy of last decade. Venture capitalists, fund managers, investors, analysts and tech watchers of all sorts would talk of a start-up’s burn rate in anxious, or even judgmental tones, and burn rate analyses became a key factor in determining the health of a company.

Think of burn rate as a very high-stakes version of “beat the clock.”

A burn rate indicated how long – generally in months – a new company could stay in business with no (or marginal) revenue and no additional funding events. The burn rate provided a time measure to the point when the next funding event would have to occur, or when the company would run out of money.

Here’s how burn rate is calculated.

So how do you calculate burn rate? In this context, burn rate is a representation of a company’s monthly operating costs. For example, if a company is seven months into its operating year and has spent $850,000 to date, the burn rate is approximately $120,000 per month.

During the dot-com era, a company’s financial staff would usually determine burn rate based on the previous 12 months of operations, due to the contractions and expansions (personnel, equipment, etc.) typical of start-up situations.

Understanding burn rate is key to keeping projects on track.

For your established or growing businesses, cash burn rate calculations can be applied to projects relating to product or service development. This can help determine what resources should be allocated to the project, how soon the project’s “ramp-up” costs will be recovered after service launch, and even if the project is worthy at all.

You probably have a fairly good notion of what it will take to keep the activity on a productive path, but a more thorough evaluation of the factors involved will provide a better indication of the “cost” side of the cost/benefit analysis. A burn rate analysis will also help your project managers focus on placing resources where they will be most beneficial to the final objective, and can potentially help prevent “scope creep.”

When it comes to a burn rate analysis, the more information you include, the better. This is a case where you’re better off throwing too much into the mix up front, than being unpleasantly surprised later.

4 costs you need to include in your burn rate calculations:

1. Set-up costs. This includes special equipment, materials, supplies, and certain technology expenditures. All this can add up quickly, especially in the early development stages. Also consider facilities and space requirements for work areas and extra storage. An easy to remember, but largely overlooked rule: Whatever it is, if you would not have acquired it had the project not been undertaken, it needs to go in the cost calculation.
2. Costs relating to outside talent. This means anyone brought in to help the project team who is not on your company’s payroll: Consultants, attorneys, contractors, IT specialists and similar personnel. These costs vary widely based on the nature of the work being performed, so using a one-size-fits-all daily or weekly rate is not advisable. When compiling your analysis, make sure estimates are categorized sensibly, preferably by a functional area (e.g., software programming) basis.
3. Salaried employees. This is tricky. It’s tempting to artificially hold down anticipated project costs by minimizing or even ignoring the input of current employees. But in a transparent analysis, you need to account for the time and effort obtained from fulltime, regular staff. That’s a straightforward calculation, but the number nudges higher if other employees must fill-in or cover for the employee absorbed by the demands of the project.
4. Slush fund. If you want to come up with something more professional or more agreeable-sounding to the boss, go ahead. In fact, you probably should. But whatever you label it, you need to consider the likelihood of costs relating to travel and other not-so-obvious expenses tied to the project. This is also a good place to plan for unanticipated minor expenses that will accrue until the project is completed.

Any project manager will tell you that unforeseen delays and expenses can throw off even the most well prepared project team. But a thorough, honest burn rate analysis can help minimize overruns and improve your team’s chances for success.

MP Star Financial’s invoice factoring services can make your cash flow more predictable and let you focus on running your business. Call MP Star Financial for more information at 800-833-3765 Ext. 150.

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