Most companies feel the burn when they miscalculate how they’re going to spend their precious dollars and then run through them way too fast.
When you blow your calculations, you’ll have way more trouble getting that next round (if, in fact, you’re still around).
Ask founders, CFOs, and sales leaders “What does burn rate mean?” or “How do you calculate burn rate?” and you’ll probably get hundreds of different answers.
As I often say, figuring out your burn rate is a process and destination -- not a shortcut. You certainly shouldn’t be using Excel as your primary means of calculating it. So…
Our favorite “dictionary” definition of burn rate is this one from The Balance:
“The burn rate tells companies how much money they're spending and how quickly they're spending it. The term is usually used in the context of a new company that's trying to ramp up its operations and become profitable. The burn rate allows growing companies to set realistic timelines because it tells them exactly how long they have before they run out of money.”
Sounds pretty simple, right?
The details of this calculation really matter, especially as they relate to the cost of sales and the expenses related to hiring and onboarding the critical people who are ultimately responsible for bringing your product to market.
Capacity Planning 101 explains those details in language that every CEO, CFO, HR manager, and Sales Leader needs to embrace. In fact, we believe that every employee of every company whether they are a start-up, scaling business, or even a unicorn must understand.
People, factors, and expenses are a significant part of every company’s balance sheet. If you make an error or don’t allow sufficient time for hiring and onboarding or your business, your burn rate accelerates rapidly and you could easily find yourself cash-strapped.
When companies are first getting off the ground, sales is often the responsibility of the CEO/Founder. Then, salespeople enter the picture (at either a tactical or senior level, depending on the type of business, the company’s growth plan, and the amount of funding available.
If you’re a first-time founder, that decision of who to hire and when is especially critical.
So, now you have at least one salesperson on board. He or she won’t walk through the (physical or virtual) door and bring thousands of dollars in deals with them. So, if you’ve assumed that one new hire equates to an immediate uptick in sales, you’ve already started burning more cash than you may have projected.
And that’s just one misstep. If you’re building an entire sales team, supported by marketing, finance, and HR professionals, you are burning cash every day you exist. I’ll talk more about that in the next section.
Effective models allow for the time humans need to come up to speed, as well as factors like vacation time, personal time off, seasonality of businesses, and economic conditions that may impact closing deals.
Setting realistic quotas and respecting the “quota ramp” are critical components of calculating accurate burn rates.
As your business grows, you may add on additional layers of sales management and perhaps even a VP of Sales. You’ll need to figure out what levels you need to hire at and what the specific roles (and quotas) need to be for each of the people you bring on. Again, the details matter and have a direct and profound impact on burn rate.
The start-up world would be a lot simpler if you could just make assumptions like:
“I’m going to hire a VP of Marketing who will generate leads for my sales team. That person will earn $150K and I’m hiring them in February. That means I can simply add $137K to what I’m spending next year. And then, I’ll hire another sales rep to follow up on those leads and that will cost me another $75K. So, I’ll spend a total of $217K and my sales and revenue will increase by at least that much as a result of the extra talent, and I’ll be whole.”
The problem with that logic is that business life doesn’t really work that way. Perhaps you need to add an HR executive or recruiting firm to bring those people on board. And you have training expenses on top of that. And then, of course, you have to be at least a little patient for onboarding and learning curves. And what if you mis-hire (which happens to all of us) and your marketing head doesn’t get along with your sales leader and you need to start the process all over again.
Most burn rate planning doesn’t take factors into account like:
Before you freak out that this (more accurate) burn rate calculation process sounds overly complex, I can set your mind at ease.
As founders ourselves, we saw (and experienced) some of these problems. We’ve also talked to companies that thought they had 19 months of runway and only really had 11. (Talk about stress!) That’s why we created BurnRate.
Rather than using an Excel spreadsheet to calculate your ramp-up and runway, you can use our automated system to collaborate on and build capacity plans that factor in all your revenue-generating expenses and allow for human realities that can have a significant impact on spending.
It makes forecasting and re-forecasting simpler, reduces errors, and even makes planning and presenting to and building credibility with your investors and board less anxiety-provoking.
Follow our blog for our upcoming installments on Capacity Planning 102 (how to hire) and Capacity Planning 103 (more details on calculating your burn rate).
Questioning your burn rate calculation? Let us help. Schedule a demo.