What Is Burn Multiple?
Burn Multiple (BM) is a metric used by startups to determine how much money they are spending to generate an additional unit of revenue in a given year. It essentially measures the number of dollars a company is burning or spending to create $1 of Annual Recurring Revenue (ARR). It is relevant to both SaaS businesses and product-making startups.
For those who may be unfamiliar, ARR (Annual Recurring Revenue) refers to the recurring revenue generated by a company’s subscription-based products or services over a 12-month period. It represents the annualized revenue the business can expect from its existing customer base.
ARR is an essential metric for investors as it helps assess the company’s financial health, customer retention, and future revenue projections.
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To calculate Burn Multiple, it’s also important to grasp the concept of Burn Rate, besides ARR.
Burn Rate refers to the rate at which a company incurs expenses to cover its monthly overhead costs. It represents the monthly expenditure incurred in running a startup.
Now, let’s delve into the calculation method for Burn Multiple.
How to Calculate Burn Multiple?
To calculate Burn Multiple, determine the Net Burn Rate and Net ARR.
In simple terms, Burn Multiple = *Net Burn / Net ARR.
(Net Burn= Total Cash Out Flow-Total Cash Inflow)
Net Burn is calculated by subtracting the Total Cash Inflow from the Total Cash during a specific period.
The resulting value represents the net cash consumed by the company during that period.
If the Net Burn is positive, it indicates that the company is spending more cash than it is generating, which signifies a cash burn rate.
On the other hand, a negative Net Burn suggests that the company is generating more cash than it is spending, which is ideal for any startup.
After identifying the Burn Multiple, you need to analyze the actual figure obtained after the calculation.
A lower Burn Multiple indicates efficient business management, while a higher Burn Multiple implies that the company is investing more money to generate additional revenue.
The Importance of Determining Burn Multiple
Investors’ expectations have evolved, and they now prefer funding startups with low Burn Multiples rather than those with high burn rates or heavy monthly expenditures.
Several factors can contribute to an increase in Burn Multiples, including COGS (Cost of Goods Sold), customer churn rates, heavy investment promotions, and other expenses. In such cases, Burn Multiples will rise.
Based on the figure obtained after calculating Burn Multiples, your startup will be categorized as follows:
Outstanding: 0.5-1.0
Good: 1.0-1.5
Mediocre: 1.5-2.0
Bad: 2.0-2.5
Terrible: >2.5
Thus, your ideal burn multiple rate should be within 0.5 to 1.5.
How to Optimize Burn Multiple
While there is no one-size-fits-all solution, here are some strategies that can help:
- Reduce Burn Rate: Control your burn multiples by keeping a check on your burn rate. Explore ways to decrease headcount and find innovative strategies to reduce COGS and transportation costs.
- Increase ARR: Increase your average revenue per user to automatically bring down your Burn Multiples.
- Increase Sale: When the sales productivity is low, burn multiples will be higher. A stalling growth will make a company spend more on operations and promotions, which can further elevate burn multiples.
- Enhance Margin: Maintaining gross and net margins can be difficult, especially if you’ve just gotten started with your startup. Diminishing margins can mean the company has to invest more while its burn multiple will rise.On the contrary, if the company’s net margins increase, its burn multiple will automatically fall.
- Improve Managerial Efficiency: A higher burn multiple indicates a lack of effective leadership at the managerial level.If the management is effective, the firm’s burn multiple won’t go high. Instead, the management will take all necessary steps to optimize burn multiple and bring it down.
In Conclusion
To sum it up, now that you’ve understood Burn Multiples, it’s time to take charge and drive towards success! Think of Burn Multiples as your handy compass, giving you a clear view of how your business is doing and catching the attention of both management and investors.
Remember, Burn Multiples can change as your startup grows, but they’re a useful tool to measure progress at different stages and funding rounds. By understanding and optimizing your Burn Multiples, you can build a strong financial foundation, earn investor trust, and pave the way for long-term success.