The burn rate measures the rate at which a company depletes its cash resources over a given period of time. The most general cash burn rate calculation is performed by measuring how much you spend over a given period. If a company has $100,000 in cash at a given point in time and $80,000 in cash one month later with no revenue coming in, its monthly burn rate is $20,000 per month. With a cash balance of $80,000, this implies the company will reach a zero cash position in four months unless it can increase its revenues.
Operating Cash Flow
While burn rate is a useful basic metric, examining the operating cash flow in more detail can help assess a company's health. A business may be able to generate cash via short-term financing or additional debt, but if the outflow of cash exceeds the inflow for an extended period, its business model may not be sustainable.
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By analyzing a company's cash flow statement, you can get an accurate measure of how quickly cash is leaving the account. The cash flow statement summarizes a company's sources and uses of cash, and the corresponding net change in the company's cash balance during the fiscal period. In general terms, net income plus non-cash items such as depreciation and amortization, plus or minus the change in working capital equals the company's operating cash flow. You can obtain operating cash flow directly from the cash flow statement. The company's net change in cash is equal to operating cash flow plus or minus investing cash flows, plus or minus financing cash flows.
Operating cash flow is a good basis for calculating cash burn, and is widely used to calculate the cash burn rate. If a company records monthly operating cash outflows of $100,000 and has a current cash balance of $1 million, this indicates that the company will run out of cash in ten months. Its monthly cash burn rate is $100,000 per month.
Managing Cash Burn
Often, by the time a company's cash burn rate has become the focus of management or investors, the company is already involved in some sort of capital restructuring, such as bankruptcy. Two common situations where the significance of cash burn rate increases are:
- New, fast-growing companies need short-term financing to survive long enough for the company to become profitable. Often, a company uses public stock offerings by raising cash approximately equal to the company's burn rate. This is to ensure the company uses the cash as efficiently as possible --or in some cases, the cash proceeds are used to pay down existing loan obligations.
- When a company is in financial distress, management must steer the company through a liquidity crisis. This typically involves creating detailed projected financial statements, with a focus on cash burn and meeting upcoming debt obligations to avoid corporate insolvency. Often, discretionary expenses are analyzed closely and reduced where possible, including head count. Other ways to slow the burn rate include the aggressive management of payables and receivables. Accounts payable cycles can be widened by delaying payments to vendors by several days, and accounts receivable can be collected upon more aggressively.