What’s Your Burn Rate and Why It Matters
You might have heard the term "burn rate" used to describe how much money a startup spends over a certain period of time. But have you ever applied this concept to your own finances? Knowing your burn rate — how much you spend monthly and annually— is the first step to gaining control over your financial life and being able to confidently plan for the future.
Why Your Burn Rate Matters
Calculating your burn rate isn’t the same as budgeting. Budgeting is more about imposing spending limits, while a burn rate exercise helps you figure out how much you’re spending in the first place, without restrictions. Knowing your burn rate provides critical insights and helps you answer questions like: Am I saving any money? How much does it cost to fund my lifestyle? Could I switch jobs comfortably?
When I start working with a client, figuring out their burn rate is one of the first exercises we complete. That’s because many of the financial questions clients grapple with — like whether they can take a pay cut, if they’re saving enough, or when they can retire — are closely tied to how much they currently spend and will need to spend in the future.
How to Calculate Your Burn Rate
Start by opening a spreadsheet or using a Google Sheet to summarize your expenses. There are various ways to organize your data, but my preferred approach is to categorize expenses into overarching buckets. Here’s how to do it:
Create Overarching Buckets: Examples include Home, Car & Transportation, and Food & Grocery, among others.
Add Specific Categories: For instance, under the Home bucket, you might include line items for mortgage/rent, property taxes, insurance, maintenance, utilities, and lawn care.
Collect the Data: Review your credit card and bank statements for the past year to identify expenses and calculate an average monthly amount for each category. This method works well if you use credit cards for most of your purchases.
Once you’ve collected and organized the data, add up all the categories to determine your total monthly spend. Multiply this number by 12 to estimate your annual burn rate.
In terms of accuracy, try to be as detailed as possible to ensure your burn rate is reflective of your level of spend, but know that it doesn’t need to tie out to your expenses 100% for you to be able to plan effectively. For example, if your annual spend is $200,000 and you’re $5,000 off on your burn rate calculation, that’s probably okay. But if your annual spend is $50,000, and you’re off by $5,000, that could drastically change the financial decisions you make.
Putting Your Burn Rate into Perspective
One of the first things you’ll be able to figure out once you have your burn rate is whether or not you’re saving any money. You can do this by comparing your burn rate to your annual net income (i.e., income after taxes):
If net income > burn rate, you’re saving money and building net worth — a positive sign.
If net income < burn rate, you’re not saving money, and likely accumulating debt — something to address.
Understanding this relationship is a crucial first step for evaluating your savings rate and assessing your overall financial health.
Applications of Knowing Your Burn Rate
Savings Assessment: With a clear view of your expenses, you can accurately determine how much you’re saving each year and whether it aligns with your goals.
Job Transition Planning: If you’re thinking about changing jobs or careers, knowing your burn rate helps you understand the minimum income you need to maintain your current lifestyle.
Planning for Life Transitions: If you’re considering taking a break from work, knowing your burn rate and your existing savings available gives you a realistic view of how long you can sustain your lifestyle without steady income.
Take the First Step
If you don’t already know your burn rate, take a couple of hours to figure it out. Revisit your burn rate periodically to adjust for changes in your lifestyle or spending habits. Understanding your burn rate is an empowering step toward making better financial decisions and building a more secure future.