If you’ve ever worked in a startup or overheard a conversation at a Silicon Valley coffee shop, you are probably familiar with the term burn rate.
Burn rate refers to how much money a startup is “burning” through each month. The burn rate lets you calculate how much time the startup has before it must turn a profit or raise more money.
For example, if a startup has $1 million in the bank and a $100,000 monthly burn rate, it has ten months to survive. It needs to make something happen before ten months is up or it will run out of money.
People have a burn rate, too. Hopefully you make more than you spend. In the startup analogy, you’re profitable. You have more cash coming in than going out, so you aren’t heading to zero in your bank account.
But what if something happened? What if you lost your job? Your business failed? You get sick? Or what if you just want the flexibility to take time off and not let money dictate your career decisions? Or you want to start a company and won’t get paid for a while?
If your income suddenly dropped, how much time would you have before you ran out of money? That’s the idea behind a Personal Burn Rate.
You need to avoid these 2 mistakes
It might be easy to figure out your personal burn rate, especially if you track your spending in Quicken or Mint. But there are two mistakes a lot of people make when calculating their number.
1. Only looking at the last month or two of expenses as a baseline. There are a number of expenses that are incurred just once or twice a year, such as vacations, furniture and insurance. You also probably spend more money around holidays such as Christmas. You should look at your past twelve months’ of spending and average it to get your monthly number. This will help you capture your seasonal and uncommon expenses. Once you get this twelve month number, just divide by twelve to get your Personal Burn Rate.
2. Dismissing a particular expense as a one-time event. “I went on an expensive vacation last year, so I shouldn’t count that in my regular spending” or “The car needed a new transmission, but that won’t happen every year.”
You shouldn’t ignore these because there’s always something.
Maybe it’s not a transmission this year, but it’s a car accident. Maybe you don’t go on an expensive vacation but have to do a house repair. Perhaps you have an unexpected medical expense.
Hopefully, looking at a year of expenses softens the impact of some of these “one time” expenses. The point is that there are always one-off expenses, even if in a different category of spending. You should include them in your overall spending calculations.
Although calculating your Personal Burn Rate is the goal, it’s handy to separate your average monthly expenses into categories. This is important as you look at ways to trim your burn rate.
I’ll discuss categories in a future post.
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