By Lior Ronen | Founder, Finro Financial Consulting

Burn rate analysis is a fantastic tool that allows founders to reduce a high burn rate, save a certain amount of cash in the short term, and use that amount of money either for other business purposes or to extend the runway.

In most startups backed by venture capital dollars, fundraising is the lifeline of the business, and therefore, they spend a significant amount of time on the fundraising process. However hard is it may be, raising funds from potential investors or existing shareholders is temporary and limited in time. 

In the background, the business keeps working and burning its cash reserves. 

To keep the business working, founders need to extend the company's cash runway either by raising additional funding or cutting unnecessary or inefficient operating expenses. 

The way to do it is by diving into the monthly burn rate and looking for potential cash-saving opportunities that could free up space in the company's gross burn rate, and burn rate analysis is the way to do it. 

This exercise does not fit every startup company and might be slightly more challenging in early-stage startups, especially SaaS companies that spend most of their cash on the payroll. 

However, this is a powerful tool that can benefit every small business that could impact a company's total cash.

There are two stages for this exercise: first, we need to prepare, and then we need to do the actual analysis. 

How to Do You Approach A Burn Rate Analysis?

First, we need to set the boundaries of the analysis. 

In this case, we're analyzing at the gross burn rate only, which looks at the company's burn rate purely from an operational expenses perspective. So if the company generated revenues, received any grants, or raised funds, this calculation ignores the incoming cash altogether.

The gross burn rate calculation considers only the operating expenses. For example, if a company spent in the last six months: $500,000 on payroll, $120,000 on rent and utilities, and $75,000 on software licenses and AWS, then the gross burn rate is:

Total operating expenses = $500,000 + $120,000 + $75,000 = $695,000

Number of months in calculation = 6

Gross burn rate = $695,000 / 6 = $115,833

Second, we need to gather the data to analyze.

We need to see the entire spending data to drive valuable insights, and the best place to start is the accounting system. Whether the company uses Quickbooks, Xero, or another system, download a report or ask your CFO for a simple report of ALL the company's spending in the last year or two.

Third, we need to define our priorities for the analysis. 

A startup burn rate includes all the company's spending. However, we usually like to start with the low-hanging fruits and proceed to more complex and challenging business decisions depending on the urgency of the savings and current cash status. 

In most cases, business owners set non-core big-ticket items as their priority for cash savings and headcount and payroll as the last priority to analyze. 

5 Steps of Burn Rate Analysis

Many entrepreneurs focus most of their time on fundraising, improving KPIs and growth metrics, BUT neglecting the bread and butter of every startup company: controlling your spending and continuously looking for cash savings.

For this exercise, we assume that the company has a proper process to track its spending and it knows its cash position. 

After we complete the analysis preparation according to the three steps elaborated above, we can look at the analysis itself. 

The analysis works in 5 steps:

1. Identify potential savings areas.

Work according to the priorities set before to look for large expenditures that you expect to cash balance this year either because they repeat every year or because you included them in your budget. 

2. Question the importance of the purchase. 

Dive into the details of each big-ticket item identified above and ask: why do we need it? Why in that specific timing? What are the alternatives? Do we need that quantity?

3. Assess potential risk if the purchase is altred.

Perform a complete analysis of the potential risks associated with canceling or amending the purchase. Ask these questions: What are the risks of not buying that item at that time? What is the risk of not buying that item at all? Can we leave without it? Can we reduce the quantity of the purchased items? What is the risk in that? Are the alternatives good enough for what we want to achieve?

4. Analyze the consequences.

Every risk listed above has a different business and financial impact. While some actions might positively affect the cash flow statement, they could be devastating for the company. 

In this stage, we map the consequences of every risk above by examining the impact of eliminating or reducing the quality of the purchase? How much money does it save? 

5. Putting Everything Together.

When you put all these aspects together, you start building your case towards a potential cash saving that might save X$ to the company if we take a particular action. The impact of the action is Y, but we could use the money saved on Z.