Venture Capital - Burn Rate

In preparing for our accounting exam (final exams for this quarter start next week with the rest of the university), I wanted to have a quick look at burn rate. One of the concepts taught in our class is cash flows of companies in different stages. An idea I wanted to look into a bit deeper was the idea of cash flows for start up companies.

Cash flow is the primary metric of financial health. For a start up company, there is a lot of money going out the door, but often little money coming in. Revenues are low or non-existant, R&D (and expenses in general) can often be high, and working capital and CAPEX are growing.

Although I've seen different "interpretations" of burn rate it is essentially an FCF which is negative. An operational definition is how much cash is going out the door excluding what is being replaced through financing activities (CFF). I would say that CFO less CAPEX is generally a good proxy of where burn rate is. The assumption is that other sources of cash flows (selling assets, raising cash through financing etc) are not guaranteed and also not sustainable.

The next important measure of financial health is the actual cash and equivalents account. Between the two values, burn rate and cash, you can approximate how long the company will survive without additional financing activities (cash / burn rate per quarter = approximate longevity in quarters).

The goal, of course, is the hockey stick shaped recovery: eventually investing enough to develop a revolutionary product or service that causes revenue and profits to go through the roof (and provided dramatic long term IRR).