Runway finance or cash runway is the amount of time a business can last without getting fresh capital. The most important thing about knowing how to calculate your company's runway finance is that it could help you from running out of money.
Early-stage startups and SMEs share several similarities. One such similarity is the lack of resources to build their dream team. More often than not, a Chief Financial Officer (CFO) isn't in on the hiring list.
That invariably means that if the company's key decision makers aren't knowledgeable about key financial terms and how to apply such knowledge to the company's benefit, the company will be at risk of folding up.
If you're just starting out and learning about running a business, runway finance is something you'll want to be aware of. This article will take you over the basics and show you why it's so important for all small businesses to have a solid understanding of their company's financial health.
Runway finance is one of such key terms to a company's success. Sadly, some founders know nothing about runway finance, how to calculate it, and why they should even care.
Here's why you should care: Funding is not a guarantee for success, as seen in the case of Fast, which raised $100 million, yet folded up. Our in-depth analysis of Fast's rise and fall shows that financial mismanagement was at the core of the company's failure. Knowing and working with their cash runway could have saved Fast from its demise.
In this piece, we'll look into;
- What runway finance is
- How to calculate runway finance
- What burn rate is
- Cash runway formula
- Why you should care about runway finance as a business owner
Let's delve right in!
What is runway finance?
Runway finance, also called cash runway, is the projected amount of time a business can last without getting more external funding. It is the estimated time a business can last based on its revenue streams and expenses before needing more external funding.
Why runway finance is important for businesses
Cash runway, a financial parameter often measured in months, is one of the must-know for every business owner because it sheds light on several things:
- your company's spending rate
- how wasteful or otherwise you've been
- how long do you have to either raise additional capital or salvage the situation
It is important to determine this figure because if it cannot be satisfied, the entire business will either go out of business or need to raise additional funds. Deploying Cash reserves during slow seasons increases the Net Burn Rate (raise in cash spent with little or no profits).
When preparing your business plan, you need to include information about your cash runway so you can determine at which point your team needs to be seeking additional capital from investors, additional funding, or your own cash reserves.
Running your business without knowing your cash runway is like kick-starting a car without the slightest clue of the controls 一 an untimely crash is almost inevitable.
How to calculate your runway?
Calculating your cash runway is the first step in planning your strategic business growth rate. It's an essential tool, especially for startups that don't have a lot of capital. The calculations require knowledge of your total cash at hand and your burn rate.
Running smart requires a solid understanding of your total available capital, cash spent, and your company's burn rate — how much money it costs you to keep the doors open, given all expenses.
What is the burn rate?
Burn rate is the degree to which your company digs deep into its capital. It is typically calculated in terms of the amount of cash the company is spending per month. This is further divided into net burn rate and gross burn rate. Let's look into them both:
Gross Burn Rate
Your company's gross burn rate accounts for your total expenses, including salaries, rent, cost of production, or service delivery, among others. It is the sum total amount of operating costs companies incur in expenses each month. To calculate your Gross Burn Rate, simply:
Summing up all monthly Operating Expenses
Net Burn Rate
The Net Burn Rate accounts for the degree to which your company is losing money. It is the pace at which a startup company is running through its startup capital ahead of generating any positive cash flow. It's an alarming metric that you can calculate using this formula:
Total Revenue - Monthly Operating Losses
Monthly Operating Expenses
Net Burn Rate
What is the cash runway formula?
The cash runway measures how long a company has to remain solvent without funding until the cash runs out. The duration of the cash runway is the number of months until there isn't enough money or going out of business. The company cash or team cash depreciates without receiving additional funds or spending cash reserves.
You can calculate your company's runway finance using this formula:
Total Cash/Burn Rate
Thus, if a company has a capital of $300,000 and a burn rate of $6,000/month, the company's runway finance is 50 months. This is better represented below:
Monthly Operating Expenses
Gross Burn Rate
Net Burn Rate
How to reduce burn rate and preserve cash reserves
When you receive the result of your runway finance calculations, there are some measures you could consider taking to elongate your cash runway. These measures will help you reduce your burn rate. Truth be told, it'd be difficult to get fresh capital if your runway finance looks gloomy.
Listed below are some measures you could consider taking to elongate and reduce the speed of your cash runway. These actions may be necessary to ensure you have enough cash and keep your business afloat.
Reducing headcount or taking pay cuts:
Your company would most likely have to consider reducing the number of employees you currently have on board or pruning the salary and benefits you pay employees. Although this measure could spark reactions among your employees, it's one effective way of reducing the burn rate. Deferring new hires, laying off non-essential workers, or limiting office spaces and benefits can lead to big savings.
You can also try motivating staff with non-cash incentives. Extra time off or more remote work flexibility are great non-cash motivators for employees who are doing a great job and deserve an extra incentive for their hard work.
Cutting off extra expenditures:
As a startup or small business, you need to prioritize making recurring revenue and cut down on expenses your company doesn't critically need.
For instance, you need not have office space. Adopt a remote-friendly work culture. If it's super important to have an office, get a small office where only the critical and must-be-onsite employees get an office space.
When faced with an extremely short cash runway, you must consider optimizing customer acquisition spending.
Focus on reducing your customer churn rate and boosting your customer retention rate.
You need a sound grasp of your cash flow, expenditure, and revenue, among other things, to ensure your company is financially safe. For the uninitiated, you could spend hours or days trying to figure out some financial calculations.
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