“Burn rate” refers to the rate at which a company spends its cash supply over time. It is the negative rate cash flowusually quoted as a monthly rate. In some crises, burn rate it can be measured in weeks or even days. Cash flow analysis tells investors whether a company is self-sustaining and signals the need for future financing.

To be burned by the burn rate

Burn rate is mainly a problem for start-up companies that are usually unprofitable in their early stages and are usually in high growth. industrially. It can take years for a company to generate profit from sales or revenue and will therefore need an adequate supply of cash to meet expenses. Lots of technology and biotechnology companies face years of life from their bank balances.

Burn rates also apply to mature companies that are struggling and carrying excessive debt. Airline stocks, for example, faced a slump after 9/11, which put the largest airlines in a cash crunch that threatened the industry. United Airlines, for example, suffered a daily cash burn of more than $7 million before looking bankruptcy protection.

If a company’s cash burn continues over a long period of time, it is likely that the company is going out of business shareholders’ equity funds and borrowed capital. Investors should pay close attention to the cash burn rate, especially if the company is seeking additional capital.

If companies burn through cash too quickly, they risk going out of business. On the other hand, if a company is burning cash too slowly, it could be a sign that it is not investing in its future and could be lagging behind the competition. An effective management team knows how to manage cash well.

Calculating a company’s burn rate

The burn rate is determined by looking at cash flow statementwhich reports the change in the firm’s firm cash position from one period to another through accounting cash flows from operations, investment activitiesand financing activities.

Burn rate = total change in cash position change/specified time period

Compared to the amount of cash a company has on hand, the burn rate gives investors an idea of ​​how much time is left before the company runs out of cash—assuming there is no change in the burn rate.

Time before cash runs out = Cash Reserves/Burn Rate

If you want to know if a company is really in trouble, compare its burn rate to working capital measured in the same period. Working capital is a company’s current assetssuch as cash, accounting receivablesand inventory, minus sa current liabilitiesinclusive accounts payable. Working capital is often used as a metric to assess a company’s short-term financial health.

Working capital / Burn rate

An example of a burn rate

Let’s consider the cash flows of a hypothetical company – Super Biosciences. To begin with, net cash FROM operating activities it was negative $5.75 million in the first nine months of the year. This means that the core operations of the business have been burning through cash at a rate of about $640,000 per month, largely due to continued operating losses.

Further, suppose that Super made some new investments in capital assets. As a result, net cash flow from investments was also negative, amounting to approximately $1.9 million. Net cash burned from operations and investing activities was more than $7.65 million – a burn rate of approximately $800,000 per month.

Some analysts argue that a more appropriate way to estimate cash consumption is to ignore cash from investing and financing activities and focus solely on cash from operations. However, this narrow focus does not seem prudent, as most firms must do capital expenditure to continue operation.

Assume that Super Biosciences has approximately $10.8 million in cash at the end of the period. Assuming Super Biosciences’ current cash burn rate doesn’t decrease, the company will run out of cash in about 13 months, which means the company’s runway is 13 months for a burn rate of $800,000 per month. To improve its cash position and avoid the fate of running out of cash, Super Biosciences can do the following:

• Reduce the burn rate through cost reductions, including layoffs or employee pay cuts.
• Generate additional cash from sales and marketing.
• Invest in R&D by smartly using cash to drive growth.
• Sell ​​the company’s assets.
• Raise external financing through issuance debt or equity.

Of course, the ability to raise more capital can be a challenge, especially for startup companies. Directors must take advantage of favorable financing periods and attractive interest rates to improve the company’s cash position and access to working capital. If a company intends to raise the necessary cash through a share issue or initial public offering (IPO)must be planned as the process of issuing additional equity can take six months or more.

conclusion

When investor enthusiasm is high, unprofitable companies may finance the cash burn by issuing new shares, and shareholders may be happy to cover the cash burn; so was the case during dotcom bubble in the late 1990s. However, when enthusiasm wanes, companies must demonstrate profitability, and if they don’t, they can be at the mercy of the credit markets.

As a result, a company with a high burn rate may find itself looking for cash from banks or lenders and being trapped into accepting unfavorable financing terms, being forced to combineor even go bankrupt. It is important for investors to monitor a company’s available cash, capital expenditures and cash flow burn rate before deciding to invest.