Burn Rate (Finance) – Definition

Cite this article as:"Burn Rate (Finance) – Definition," in The Business Professor, updated April 28, 2019, last accessed October 29, 2020, https://thebusinessprofessor.com/lesson/burn-rate-finance-definition/.


Burn Rate (Financial Capital) Definition

Venture capital is spent by a new company for overhead finance prior to the generation of its operations positive cash flow is described as burn rate. This is the measurement of negative cash flow. Cash spent monthly is how burn rate is typically quoted. For instance, a company that spends $1 million per month would have a burn rate of $1 million.

A Little More on What is the Burn Rate

The monthly cash spent by investors and startup companies is tracked by the burn rate. The burn rate a company uses also is a guide to measure its runway, the available timeframe the company has before all of the money is gone. In this figure, there is $1 million dollars in the bank. Every month the company spends $100,000, therefore the actual burn rate would be equal to $100,000 and the runway would equal 10 months. This is formulated as ($100,000) divided by ($100,000) =10.

Gross burn and net burn are the two types of burn rates. The total amount of operating costs incurred in a calendar month is the companies gross burn. The total amount of money lost by a company monthly is the net burn.

A gross burn rate of $30,000 for a technology startup would be if it spent $5,000 on the rental of office space, monthly server costs equaling $10,000, and $15,000 on wages and salaries for the engineers. But the net burn rate would be different if revenue was already being produced by the company. For a company that has monthly revenues of $20,000 and $10,000 (COGS) cost of goods sold, operating at a loss would still see a reduction in its overall burn. The net burn would be $20,000 in this scenario when calculated as: $20,000 – $10,000 – $30,000 = $20,000.

The amount of money in the companies bank and the financial runway are both affected by this distinction and that is very important here. If $30,000 is the gross spending, and the actual loss per month is $20,000 and the bank balance is $100,000 then the runway would be five months instead of only three months. The net burn is what dictates how company strategies are handled by the managers and the investment amount that an investor would want to give to the company.

Regardless of the amount of money in the bank, when the forecasts are exceeded by the burn rate or when expectations of revenue fail to be met, the burn rate must be reduced as a manner of recourse. The result is normally a reduction in staff at this point.

References for Burn Rate

Academic Research on Burn Rate

A rude awakening: Internet shakeout in 2000, Demers, E., & Lev, B. (2001). A rude awakening: Internet shakeout in 2000. Review of Accounting Studies, 6(2-3), 331-359.

The risk concept for entrepreneurs reconsidered: New challenges to the conventional wisdom, Janney, J. J., & Dess, G. G. (2006). The risk concept for entrepreneurs reconsidered: New challenges to the conventional wisdom. Journal of Business Venturing, 21(3), 385-400. This study shows the construct of entrepreneurial risk focused on deciding to launch a new business may have risks that differ from what is discovered in already established firms. The emergence of opportunities is often created by a specialization of knowledge: the characterization of this knowledge is related to start-ups concerning information asymmetry and rent appropriation. The suggestion is that these concerns are not accounted for properly through traditional measures of risk; thus, attached to entrepreneurs is greater risk-taking, particularly when the knowledge specialization is complex. Alternative measures are suggested here that encapsulate these concerns, including cash burn rates and the dilution of control when equity is issued.

Cash crisis in newly public Internet-based firms: An empirical analysis, Mudambi, R., & Treichel, M. Z. (2005). Cash crisis in newly public Internet-based firms: An empirical analysis. Journal of Business Venturing, 20(4), 543-571. This paper reviews why some new businesses prosper, and others struggle to survive when the constraints of financial resources are relaxed significantly.  Between 1997 to 1999 approximately 200 new Internet ventures went public and using the data collected it is proposed that the performance of these ventures has characteristics to function in pre-initial public offerings (IPO). The performance of struggling new ventures is determined by firm-level characteristics that includes financial positioning, top management team (TMT), location, and networks. A strong signal of impending crisis is when the entrepreneurial team’s equity holdings are substantially reduced as evidenced through agency relationships. Oddly enough, a signal crisis wasn’t observed in venture capital (VC) backers’ similar reductions.

Financing under extreme risk: Contract terms and returns to private investments in public equity, Chaplinsky, S., & Haushalter, D. (2010). Financing under extreme risk: Contract terms and returns to private investments in public equity. The Review of Financial Studies, 23(7), 2789-2820.

Motivation, success, and problems of entrepreneurs in Venezuela, Zimmerman, M. A., & Chu, H. M. (2013). Motivation, success, and problems of entrepreneurs in Venezuela. Journal of Management Policy and Practice, 14(2), 76-90.

Entrepreneurs’ opportunities in technology-based markets, Walsh, S., & Kirchhoff, B. (2002). Entrepreneurs’ opportunities in technology-based markets. Technological entrepreneurship, 2, 17.  This paper shows that entrepreneurs are a necessity as a solution to unemployment especially in a country like India, having as many job creators as possible is good. Entrepreneurship is promoted by a variety of government and non-government agencies alike. In India, the Department of Science and Technology (DST) umbrella’s a variety of other agencies that are doing great work in the promotion of techno entrepreneurship. Under the DST the National Science and Technology Entrepreneurship Development Board has been established. The aim of this paper is to provide information, explanation, and study that relates to supporting the conversion activities from Techno-innovation to Techno-Entrepreneurship by maintaining the focus of the incubation of Technology-Business approaches within India. The review provides the opportunity for Techno-Innovation and Techno-Entrepreneurship to establish a relationship in the conceptual model. In real life application, illustrations by a variety of Techno-Entrepreneurship and Techno-Innovation will be substantiated. Technology Business Incubation has the primary focus to approach support and creating Techno-Entrepreneurship derived from Techno-Innovation. In the area of Techno-Entrepreneurship going through Techno-Business Incubation in India’s context this paper will reveal a gap in research. In this context, looking toward the future in a broader sense this type of research can be very useful. In this area in the context of India, this paper will give additional ideas about the type of research that is possible looking forward.

The real effects of financial constraints: Evidence from a financial crisis, Campello, M., Graham, J. R., & Harvey, C. R. (2010). The real effects of financial constraints: Evidence from a financial crisis. Journal of financial Economics, 97(3), 470-487. During the global financial crisis in 2008 1,050 Chief Financial Officers (CFOs) were surveyed in the United States, Asia, and Europe to assess directly whether any credit constraints were experienced by their firms. This type of survey-based measurement of financial constraint is studied to view how spending plans differ. Capital spending, tech spending, and employment are some of the deep cuts that constrained firms planned as indicated by the evidence presented. In order to fund their operations, constrained firms sold more assets, drew on lines of credit heavily, and burned through more cash in fear of banks restricting future access. During the credit crisis of 2009, 86% of U.S. CFOs in constrained firms reported that attractive projects they had investments in were restricted and many other firms reported that an external inability to borrow led to a bypass of investment opportunities that were also attractive. Planned investments were either postponed or altogether cancelled by more than half of the respondents. These results are steadfast in Asia and Europe and in those economies are stronger in many cases. In conclusion, real firm behavior knowledge and approaches in the impact of credit constraints are added to the portfolio.

Determinants of Revenue‐Reporting Practices for Internet Firms, Bowen, R. M., Davis, A. K., & Rajgopal, S. (2002). Determinants of RevenueReporting Practices for Internet Firms. Contemporary Accounting Research, 19(4), 523-562. Internet firms are pressured to report high levels of revenue and accounting regulators (Financial Accounting Standards Board) and the financial press (the Securities and Exchange Commission) have expressed concerns. Aggressive revenue-recognition policies are allegedly adopted by Internet company managers’ who are influenced by economic factors and market capitalization and revenue associations as revealed in this study. Grossed-up sales levels and advertising barter revenue reporting is influenced by hypothesized factors according to this examination. Across Internet sectors the use of grossed-up and barter revenue is reviewed through the descriptive evidence provided. These accounting polices although common in a few sectors are not overall pervasive this study finds. Advertising barter and grossed-up revenues that Internet companies have the opportunity to report are the focus of empirical analyses. Management’s discretion may be limited by certain constraints and our predictions are cross-sectional and are based on internal and external incentives used to maximize revenues. The likelihood that a firm will report barter and/or grossed-up revenue is increased by the following factors we predict: a higher usage of stock options in employee compensation, increased activity in the pursuit of growth through acquisitions, increased investor interest in the company’s stock on the individual level, and less time required for additional external financing. An inexpensive way for a company to evaluate potential partners content alliances or future marketing viability is through barter transactions we propose. The extent of management ownership, the firm’s auditor or underwriter quality and reputation are all related to the constraints of management discretion according to our predictions. Grossed-up revenue and barter reporting are consistently associated with firms that have high levels of Motley Fool activity and greater cash burn rates according to our study.

Venture capitalist-entrepreneur relationships in technology-based ventures, Sapienza, H. J., & De Clercq, D. (2000). Venture capitalist-entrepreneur relationships in technology-based ventures. Enterprise and Innovation Management Studies, 1(1), 57-71. A brief synopsis is presented through this paper of literature focused on technology ventures that are venture capital backed. The characteristics highlighted in this literature are the venture capitalist rationale for entrepreneur parings and the differences in the approach used by venture capitalist toward high tech ventures to other ventures in comparison. Between the intersection of venture capital and new technology-based firms, future research and the implications for practice are discussed here as well.

Asset liquidity, debt covenants, and managerial discretion in financial distress:: the collapse of LA Gear, DeAngelo, H., DeAngelo, L., & Wruck, K. H. (2002). Asset liquidity, debt covenants, and managerial discretion in financial distress:: the collapse of LA Gear. Journal of financial economics, 64(1), 3-34. The equity in L.A. Gear’s market value drastically fell from $1 billion in 1989 all the way to zero in 1998, but during the 1980’s it was a growth stock that was hot. Through working capital liquidations, the firm’s losses are subsidized as management tried a series of radical strategy shifts as revenues began to decline precipitously for a period of six years. As illustrated in the L.A. Gear case, during financial distress managers can gain substantial operating discretion through asset liquidity (not limited to excess cash as broadly construed. Additionally, it is also revealed that (1) requirements of meeting cash interest payments are not as strong of a disciplinary mechanism as debt covenants can be, (2) instead of cash flow, earnings are constrained by debt contracts, (3) the reason why cash balances aren’t comparable to negative debt, and (4) why maturity of debt is important. Should the need arise losing operations are subsidized by managers with firms that have highly liquid asset structures.

Financial flexibility and the impact of the global financial crisis: Evidence from France, Bancel, F., & Mittoo, U. R. (2011). Financial flexibility and the impact of the global financial crisis: Evidence from France. International Journal of Managerial Finance, 7(2), 179-216. A lower impact from the crisis is found in firms that have a higher financial flexibility according to the main finding of this study. Within their business operations the results reveal that firms maintaining higher internal financings are more likely to have a leverage that is lower, cash ratios that are higher, and will incur less of an impact from the crisis. Similar to the Altman Z-score an index that is based on a company’s operating ratios, liquidity, and leverage is a better measure of financial flexibility that the usage of the long-term debt ratio as indicated by the analysis. As part of a firm’s business strategy, the evidence also suggests it is important for decisions related to capital structure to maintain financial flexibility.

The role of book income, web traffic, and supply and demand in the pricing of US internet stocks, Hand, J. R. (2001). The role of book income, web traffic, and supply and demand in the pricing of US internet stocks. Review of Finance, 5(3), 295-317. During the tempestuous year of 2000, this paper assesses the degree of comparison between non-internet stocks and the Internets cross-sectional pricing. It is found that long-term rate of growth earnings and analysts 2001 forecasts of earnings are closely related to randomly selected firms and firms that went public have similar equity market values, despite the differences in the economic fundamentals. For firms with intensive web traffic this is not the case. In March of 2000 when Internet pricing hit its peak, firms that were web-traffic-intensive were rewarded by the market, but profits were not rewarded; additionally, after the peak the markets view was reversed and losses were not rewarded, but profits were. Both at and after the peak of the Internet beyond earnings, web traffic iis considerably priced positively. There is no evidence to support the relevance of value for Internet firms that the supply and demand of two proxies is forced by the degree of short interest and public float. The argument can be made however that during 2000 the similarities between non-Internet firms and Internet firms cross-sectional pricing are enough that it was unlikely that Internet stocks pricing was completely irrational. In conclusion, it is revealed that short interest and public float related to the pricing of Internet stocks are not linked to any irrationality.

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