Burn rate is a term that is synonymous with a business, but I believe it is something that every family should consider. If we began to handle our personal finances more like a business, we could be in a better financial position.
So what is burn rate anyway? Good question
Burn rate is the rate at which a new company is spending its venture capital to finance overhead before generating positive cash flow from operations. Burn rate is normally calculated on a monthly basis, so it is how much money a company spends a month in operating expenses. This is considered gross burn rate. Now let’s look at burn rate on a personal finance level.
Let’s use a real world example—a family named the Your family. This family generates $10,000.00 a month; take home pay is $7,375.00 per month. The Your Family has $5,422.00 in expenses each month, which includes housing costs, food, utilities, automobile expenses, personal care, entertainment, etc. This family’s gross burn rate is $5,422.00.
Then we must consider another aspect of burn rate. It is called the net burn rate. Net burn rate is different because now we measure how much money the business or family loses each month. To calculate net burn rate for an individual, we must calculate two things: 1. The amount of income that is produced each month and 2. The amount of money that a family or individual has in the bank and in cash equivalents (stocks, bonds, cryptocurrency, CDs, etc.).
It is important to note when calculating cash equivalents that we only include items that can be liquidated into cash fairly quickly, (less than two weeks) which doesn’t involve leveraging debt. Therefore, things like equity in your home would not be considered, nor funds in a retirement account or availability on a credit card.
Then we divide that number by the gross burn rate. This will tell how long a family or individual has before running out of cash. This is known as the financial runway.
The Your Family has $20,000.00 in cash and cash equivalents on hand and they produce $7,375.00 per month. To calculate their net burn rate we would divide $27,375.00 by $5,422.00.00 (27,375 / 5,422). The result is 5, this is the Your Family’s financial runway. This means without any unforeseen circumstances, the Your Family can survive up to 5 months.
The idea is to know your numbers. If we know our numbers we will make better decisions with our money. What is your burn rate (gross and net)?
If you find that you need more financial runway, the good news is you can create more runway by building wealth.