Part 2 of 3-Part Series
Of course, there are many ways to change this number throughout their initial time. The most obvious is reducing their burn rate or the dollars they are burning each month. This can be done through cost cutting measures such as rent, staff salaries and other expenditures. The other is actually generating some revenue during that time which would offset the burn rate. If the same company started to earn revenue during the initial 10-month period, it would also increase the number of months they can stretch the 1 million investment. Say they started to generate $25,000/month from month number 4, it changes the burn rate to $75,000 and increases the overall timeline from 10 months to 12 months.
This initial period we’ve been referring to is called the “runway”. The runway tells businesses how long they have before they have to “take off” and survive on profits, rather than savings. The burn rate is expressed in a monthly value for the most part, but it can be used for any measurement of time from daily to yearly or more. A more frequent time is useful for a very new company, while a more established company might be fine with a quarterly or longer timeframe. The burn rate is not used past the start-up phase very often as businesses will be operated on revenue alone when they are in the growth or other phases.
It’s important to understand that while a higher burn rate means more cash is being used, it doesn’t automatically mean that is a bad thing. In the beginning of most businesses, a lot of money is spent to get it up and running. As the company progresses, the expenditure will either come down, the revenue increase to cover the expenditure or a combination of both. But money must be spent to get to the point of profitability and this is why there is an initial investment for the influx of cash which is needed. The importance of the burn rate isn’t actually to show how much money is being spent, but rather how much time they have to become profitable or secure additional funding. It is quite normal for businesses to operate at a loss in the beginning.
Part 3 continued next week.