Burning

Burning (also known as 'Cash Burn') is the rate at which a company is spending its cash reserves to finance overhead before generating positive cash flow from operations. It’s a measure of negative cash flow, essentially showing how quickly a company is losing money. Imagine your bank account: if you spend more each month than you earn, the rate at which your balance shrinks is your personal burn rate. For businesses, especially startups and high-growth companies, burning cash is often a necessary part of the journey. They invest heavily in product development, marketing, and hiring to build a foundation for future profits. However, for a value investor, a high and uncontrolled burn rate is a major red flag. It's a ticking clock that measures a company's financial runway—the amount of time it has before the money runs out. Understanding this metric is crucial for separating promising growth stories from businesses heading for a financial cliff.

The burn rate isn't just an abstract accounting figure; it’s one of the most direct indicators of a company's immediate survival prospects. For an investor, it provides critical insights into several key areas.

The most direct implication of cash burn is the company's runway. The runway is the number of months the company can continue operating before its cash pile is completely depleted. You can calculate a rough estimate like this: Runway (in months) = Total Cash on Hand / Monthly Net Burn Rate A company with $12 million in cash and a monthly burn rate of $1 million has a runway of 12 months. A short runway (less than 12 months) signals significant risk, as the company is under immense pressure to either become profitable or secure new funding, which may not be available on favorable terms.

A burn rate also serves as a grade for management's financial discipline. A sensible management team invests cash strategically to fuel growth, such as improving the product or acquiring customers efficiently. In contrast, an undisciplined team might squander cash on lavish perks, bloated administrative costs, or ineffective marketing campaigns. A steadily increasing burn rate without a corresponding increase in revenue or key growth metrics can indicate poor capital allocation or a flawed business model.

Companies burning through cash must eventually find more. The most common way to do this is by issuing new shares of stock. While this refuels the company, it comes at a cost to existing shareholders: dilution. When a company creates and sells new shares, the ownership stake of every existing shareholder is reduced. Your slice of the corporate pie gets smaller. A company that constantly needs to raise money to cover its burn is a company that will continually dilute its early investors.

Figuring out the burn rate doesn't require an advanced degree in finance. You can find the necessary information in a company’s quarterly or annual financial statements, specifically the statement of cash flows.

The simplest way to approximate the burn rate is to look at the change in the company's cash position over a period, after accounting for any financing activities. Net Burn Rate is the most commonly used metric. It represents the total amount of money a company has lost during a period. For example, if a company starts a quarter with $20 million in cash and ends it with $15 million (without having raised any new debt or equity), its net burn for the quarter was $5 million. The monthly burn rate would be approximately $5 million / 3 months = $1.67 million per month.

Context is everything when judging a burn rate.

• A “Good Fire” (Strategic Investment): For a startup or a company entering a new market, burning cash can be a sign of ambitious investment. If the money is being spent on Research and Development (R&D) that leads to a breakthrough product or on a marketing campaign that is efficiently acquiring long-term customers, the burn can be seen as a strategic investment in future value. The key is that the spending is creating tangible assets and a clear path to profitability.
• A “Bad Fire” (Operational Inefficiency): For a mature, established company, a persistent cash burn is a serious problem. It suggests the core business is fundamentally unprofitable. It's a sign that the company's revenues are not enough to cover its operating expenses, a clear indicator of a broken business model. A value investor typically runs from this kind of fire.

Before investing in any company that is burning cash, a prudent investor should ask a few critical questions. This simple checklist can help you separate a calculated risk from a reckless gamble.

• What’s the trend? Is the burn rate decreasing over time as revenues ramp up? This is a healthy sign that the company is moving toward self-sustainability. An accelerating burn rate is a cause for concern.
• Where is the money going? Dig into the financial statements. Is the cash being spent on scaling the business and creating value, or is it being consumed by high salaries and administrative overhead with little to show for it?
• How long is the runway? Calculate the runway yourself. Does the company have a comfortable cash cushion (ideally 18+ months) to execute its plan, or is it operating on borrowed time?
• How strong is the balance sheet? Beyond cash, does the company have low debt? A strong balance sheet can provide a safety net if the company needs more time to reach profitability.
• What's the plan? Has management clearly and credibly articulated how and when they expect the company to stop burning cash and generate profits? Look for specific milestones and targets in their communications with investors.