The Meaning of Burn Rate & Why It’s Important
Have you heard the term burn rate or cash burn rate but weren’t entirely sure what it meant? In this post we’ll explain the meaning of this word, illustrate a simple calculation, and explain why this concept is important.
Burn Rate Meaning & Definition
Burn Rate Definition: The term burn rate simply means the amount of cash a business or person spends each month. The word is often associated with start-up businesses or venture backed businesses as a measure of the rate the new business is spending it’s cash. However, the term is becoming increasingly used in a personal finance context to illustrate what a person or family spends each month.
Burn Rate Calculation
Here’s a simple example to help illustrate the meaning of burn rate:
Say a business spends $10,000 per month on payroll, $3,000 per month on rent, and $2,000 per month on everything else. The resulting burn rate would be $15,000 ($10,000 + $3,000 + $2,000).
If the business has $150,000 in the bank that would mean it has 10 months of runway ($150,000 cash in bank / $15,000 monthly cash burn) before running out of cash. This is assuming no revenue. If the firm had revenue then a net burn rate could be calculated. For instance, if the same business was making $5,000 per month in revenue the net burn rate would be $10,000 ($15,000 – $5,000) or provide a runway of 15 months.
Personal Burn Rate
Why should you care about your personal burn rate?
Your personal burn rate is critical to know… if you are spending more each month than you are taking in you will soon be in a bad place financially. Further, if don’t measure something it doesn’t become a priority. The most successful people I know are laser focused on important metrics like monthly spending. They want to know how much they are earning and spending each month. Covering your monthly spend with passive income is the dream for many people. If you can do this you’ll be financially independent and never have to work again.
Burn Rate and Financial Independence
Financial independence means exactly what it sounds like; you have saved enough money that you no longer need to work in order to live. People that are financially independent no longer need to trade their time for money. Instead their money works for them. People who are financially independent may still work or they may pursue interests, participate in a charity, etc.
What does any of this have to do with your monthly burn rate? Knowing your monthly burn is critical to understanding what you need for financial independence.
Say you have a monthly burn of $4,000. This includes everything you spend money on. Your mortgage, auto, cell phone, food, travel, etc. A monthly burn of $4,000 equates to an annual burn of $48,000.
If I wanted to retire early and achieve financial independence how much would I need saved?
According to the 4% rule you’d need $1,200,000 saved or invested ($1,200,000 * 4% = $48,000). You can see that understanding your burn rate is key to knowing if you can achieve financial independence. Further you can see there are two big factors when it comes to getting to financial independence: making/saving more money or spending less money. If your burn rate was only $2,000 per month you could retire on $600,000.
Monthly Nut vs Burn Rate
There is another term called monthly nut which closely relates to burn rate. Monthly nut is essentially the same thing as burn rate but is most often discussed in the context of real estate.
For example, say you rent out a house you used to live in. The mortgage is $1,200 a month, utilities are $300 a month, and taxes/insurance are $200 a month. Your monthly nut in this example would be $1,800 ($1,500 + $300 + $200). Your burn rate / monthly nut / monthly expenditures are equal to $1,800 so ideally you are charging your renters over $1,800 to cover your monthly nut.
Burn Rate Summary
Burn rate is another way of saying monthly expenses. It is the total of all money you are spending each month. The term originated in the context of start-ups but increasingly is talked about for individuals and families.
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