I read an excellent book recently called Angel, written by Jason Calacanis - one of the most successful investors in start-ups of all time.
He was an early investor in Uber and Thumbtack and made millions from investments which often began in the thousands.
Anyway, in Angel, Calacanis has many different criteria when deciding whether to invest in companies or not, and one of them is finding out what the company’s burn rate is - a key measure of sustainability and how long a company can stay in business.
A burn rate is the rate at which a company loses money. It’s simply the amount they are spending each month over the amount they are in taking in.
Another term associated with it is, what a company’s runway is. This is the length of time their business can operate assuming its current burn rate.
If, for example, a company raises €100,000 and has a net outgoing (burn rate) of €10,000 each month, if that doesn’t change they will run out of money in 10 months (runway).
Some 90% of start-ups fail, and there could be any number of reasons why, but, ultimately, the reason they have, to close is because they run out of money.
Founders are keenly aware of this phenomenon, as is any business owner.
They must constantly review and measure income and outgoings, and endeavour to keep expenses as low as they can for as long as possible, because cash flow is the difference between being in or out of business.
If only we treated our own finances like we would if we ran our own business we would spend more time looking after our finances and look for ways of increasing our income and reducing our outgoings.
From a personal perspective, knowing what your burn rate is very important because it reminds you that at some stage in the future you could run out of money, if you don’t start making adjustments i.e. increasing your income and/or decreasing your outgoings.
There may come a time, like a start-up, when you are in danger of running out of money especially if you aren’t earning an income because of redundancy, illness etc.
Unlike a company, though, you won't have an opportunity to pitch to investors looking for more money because they don't want any equity in your personal finances.
Would you invest in someone whose burn rate meant they would run out of money in, say, less than three months?
Of course you wouldn’t which is why having sufficient emergency funds in place, and more importantly having your spending under control is so vital.
There are two ways you can decrease your burn rate; earning more or spending less, or a combination of both. Earning more and spending less are not the same though. If you earn an extra €100, you have to pay taxes, USC, PRSI etc. You will probably have about €65 left over. But if you spent €100 less, you are getting the full value of that €100. So, finding that €100 from spending less gives you more bang for your buck.
I carried out such an exercise for a couple recently where we analysed their daily burn rate. We began by looking at how much they earn per day and what they spend per day.
Between them they earned €209 per day but they spent €224 so we weren’t off to a great start.
But, it was that reality check they needed which would help get their heads out of the sand and take some notice and responsibility about how they managed their money.
We looked at every possible area, from pet food, to clothes, to insurance to meals at work, and to calculate what they spend each day, we averaged it out over 365 days.
Some of what we uncovered revealed they spent €7.52 on meals at work each day; €11.23 on health, beauty and fitness; €15.07 on clothes; €41.65 on household food shopping; €0 on personal development and €6.19 on transportation costs.
So, why do we need this information? For me, it’s clear that every euro matters and every one we spend is one we have to earn. We all know this, but we would rather not take that deep dive to find how and what we spend our money on.
Small amounts might seem insignificantly low when spent on a daily basis, but they aren’t so small when you add them up over 12 months.
So, €7.52 per day on sandwiches might seem very small but it’s €2,745 a year. I’m not suggesting you shouldn’t continue to buy sandwiches or coffee or whatever it is you spend small amounts on each day.
What I am saying is that you should be aware of what the amounts are relative to your daily spending rate.
We all have a bit of leakage in our monthly spend but taking time out to evaluate and analyse your daily burn rate has many advantages from redirecting some of what you spend to other areas of your finances, to earning less, to retiring earlier.
Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie