What is Cash Runway and Why is it Important?
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Introduction
Cash runway is a term that refers to the amount of time a business can stay in operation before running out of money. It is calculated by dividing the company's current cash balance by its burn rate, which is the amount of money it is spending each month. For example, if a startup has $100,000 in cash and a burn rate of $10,000 per month, its cash runway would be 10 months. Cash runway is a crucial metric for startups and small businesses, as it can help them determine whether they need to find additional funding or cut expenses in order to stay afloat.On the other hand, a startup with a longer cash runway has more time to focus on growing its business and increasing revenue.
In addition to helping businesses stay afloat, understanding and managing cash runway can also help startups be more strategic in their fundraising efforts. By knowing their cash runway, startups can be more targeted in their efforts to secure additional funding and avoid running out of money before they are able to secure the funding they need.
Overall, cash runway is an important metric for startups and small businesses because it helps them understand their financial health and make informed decisions about how to manage their finances. By understanding and managing their cash runway, startups and small businesses can position themselves for success and avoid financial challenges that could threaten their viability.
Formula for calculating cash runway
The formula for calculating cash runway is relatively simple:
Cash Runway = Current Cash Balance / Burn Rate
The current cash balance refers to the amount of money a business has available to it at a given time. The burn rate is the amount of money the business is spending each month. By dividing the current cash balance by the burn rate, you can determine how long the business can stay in operation before it runs out of money.
For example, if a startup has a current cash balance of $100,000 and a burn rate of $10,000 per month, its cash runway would be 10 months. If the burn rate increases or the cash balance decreases, the cash runway will also decrease.
It's important to note that there are two types of burn rate: gross burn rate and net burn rate. Gross burn rate refers to a company's total operating costs, while net burn rate takes into account revenue and profits. For example, a startup with a gross burn rate of $30,000 per month and revenue of $20,000 per month would have a net burn rate of $10,000 per month. The type of burn rate used can affect the calculation of cash runway, so it's important to understand the difference between the two.
Gross burn rate vs. net burn rate
Gross burn rate and net burn rate are two terms that refer to the amount of money a business is spending each month. Gross burn rate is the total amount of operating costs a business has, while net burn rate takes into account revenue and profits.
Gross burn rate is the total amount of money a business spends on operating costs, such as rent, utilities, salaries, and supplies. For example, if a startup spends $5,000 per month on rent, $2,000 on utilities, and $10,000 on salaries, its gross burn rate would be $17,000 per month. Gross burn rate is important to understand because it gives a business an idea of its total expenses and how much money it needs to bring in to cover those costs.
Net burn rate, on the other hand, takes into account a business's revenue and profits. It is calculated by subtracting a company's revenue from its gross burn rate. For example, if a startup has a gross burn rate of $17,000 per month and revenue of $20,000 per month, its net burn rate would be $3,000 per month. Net burn rate is important because it gives a business an idea of how much money it is losing or gaining each month, and can help it make strategic financial decisions.
Understanding the difference between gross burn rate and net burn rate is important for businesses, as it can affect their calculation of cash runway. By understanding both types of burn rate, a business can make informed decisions about its financial health and plan for the future.
TYPES OF CASH FLOWS
Company cash: This is the cash flow used to pay for day-to-day expenses, including rent and supplies.
Team cash: This is the cash used to pay employees.
Founder cash: This is the founder’s own cash reserves, which may be tapped into to keep the business from going under.
HOW TO REDUCE CASH BURN RATE
- Grow your revenue: This is probably the most obvious and perhaps least likely option, but maybe you can pivot your business, discover a new business model and figure this out.
- Cut your payroll: This is of course always painful and hopefully, you can look to cut other expenses first.
- Reduce or cut expenses: Can you trim marketing expenses? Take a close look at your budget and cut anywhere you can.
- Negotiate lower costs: Talking to your vendors is always a good idea. They’d rather keep you as a customer than lose you entirely and will often offer discounts.
- Sell excess inventory: If you can sell any extra inventory to another company, that can generate cash for your business.
- Encourage cash sales: If you can get more customers to pay in cash vs invoicing them, you’ll end up with more cash on hand, faster.
- Delay paying your bills: Slowing down bill payments is never ideal, but it can put you in a better cash position temporarily.
GUIDELINES / PRINCIPLES
- Minimize the Impact on your Employees: Make employees focus on providing the best service or product.
- Limit the risk factor: Exercise control on things that can be controlled.
- Set up a for a massive growth after a downturn pass
HOW CASH RUNWAY COULD BE BOUGHT UP IN STARTUPS
The more dollars in hand, the longer the runway is, it will take more time for the business to grow.
Flexibility is key, because you don’t want to go into a fundraising round without any remaining cash on hand. Once you determine your burn rate and runway, you can be more strategic heading into those funding discussions. That should help avoid a situation where you feel like you have to take whatever deal investors are offering.
- Neglecting Communication: the effective communication between team members is essentially worth scheduling the budget. Helps in multitasking and tuning out important conversations and questions.
- Expecting things to go as planned. Unanticipated expenses are an oxymoron in the startup world, as companies should prepare for just about anything.
- Asking for too little when your business is crunched for cash, excessive frugality is an easy mistake, Chmelir said. When talking to potential investors, he says to “be really clear on how much you need.”
Finanshels is dedicated to making accounting and bookkeeping as simple and informative as possible. Learn more about cash runways and how to calculate them in the simplest way possible!
Contact us today for a free consultation to help you reach your financial goals.
