Dealing with startup finance is a tough job for every founder. You spend money faster than you get it (if you’re lucky enough to obtain it at all). Bootstrapping is possible. However, most startups rely on outside financing. They also cultivate their ability to save money and survive as long as possible before the successful product hits the market.
While there are many unknowns, one thing is sure to happen: you’ll spend your initial funding in no time. Today, we explain the burn rate, managing expenses, and staying afloat.
What is Burn Rate?
It’s the amount of money you spend in your SaaS startup at a given period (usually, a month). It includes total expenses: the cost of goods sold, R&D, sales and marketing, and general and administrative. Some sources describe it as an extent of negative cash flow.
How Does Burn Rate Work?
If the burn rate is the same as the spending, why have a different term? First of all, this is one of the SaaS Metrics more relevant to startups. The operations use initial cash reserves and don’t generate revenue yet, ‘burning through’ the cash available. Second, your focus should be its correlation with your revenue. SaaS burn rate helps you identify your startup’s overall lifespan, instead of just stating your expenses.
Two types of burn rates exist; gross and net. While this differentiation might seem superfluous, they have a very distinct difference. At this point, the focus on revenue comes to the spotlight. Let’s use an equation to illustrate the issue:
Total revenue – Gross burn (total expenses) = Net burn (cash flow)
So, while ‘gross burn’ is the cash your startup needs to survive monthly, ‘net burn’ is the amount left after you subtract the former from the total revenue.
How Do Revenue, Gross Burn Rate, and Net Burn Rate Correlate?
Gross and net burn rates can be equal when your company has no revenue. Things change when you start making money. When you have a positive income, this equation can bring forth three mathematical scenarios:
- Total revenue is smaller than gross burn, resulting in a negative net burn rate
- Total revenue is equal to gross burn rate, leading to breaking even
- Total revenue is bigger than gross burn, contributing to positive cash flow and profits
The first scenario is what happens with SaaS companies at the beginning. You’re working on a product but haven’t started selling to customers. This development stage has to be as short as possible. The business needs to become self-sufficient at some point and stop depending on outside funding.
The second scenario is when your company’s total revenue and expenses cross each other out. Neither losing nor earning any money is the first positive step for growth. Around 43% of SaaS startups fail because there’s no market need for their software. However, when customers start using your product, you’ve averted the most common cause for startup failure: you’ve created a viable output.
The third scenario is the more positive one for the company. As you earn more than you spend, you find the enterpise in a better financial condition than most new businesses. Steady growth is the primary factor in reaching this point.
Net Burn Rate Isn’t ‘Loss’
Talking about the burn rate as ‘money lost’ is an accepted benchmark term in the industry. Yes, technically, you ‘lose’ money, but it can positively impact the company’s growth.
While the burn rate is a handy metric, it’s also one faceted and raw. Using it as the only number to evaluate your SaaS finance and further obsessing about it won’t set you on the right path. Its most crucial function is to put spendings into perspective.
Reducing costs is always a good idea, but try to think about the burn rate as an opportunity to answer some essential questions about your business:
- How long will you be able to stay afloat? In other words, what’s your runway? (We’ll talk more in-depth about this in one of our next posts, so stay tuned)
- When should you anticipate your next funding round?
- How much money (and time) do you still need to achieve a minimum viable product?
- Will you start making positive cash flow without more funding?
Finally, spending more money targeted at growth is beneficial. It shouldn’t reduce if you can justify it. Look at this statistic in conjunction with other SaaS metrics like customer acquisition cost and customer lifetime value. This perspective will shed more light on your company’s future.
While it’s essentially the amount you spend on operations, burn rate is a concept native to the changing and growing SaaS startup industry. When combined with other stats, this metric can become a powerful tool to describe your business’s broader capabilities and milestones.
As we make our way through business-related concepts, we touch upon different essential metrics, terms, and calculations that can prove handy for any startup founder, CFO, or other team members.
If you want to know more about the burn rate and other SaaS metrics definitions, don’t forget to check SaaSpedia.