Cash runway is the amount of time a business can last without getting an influx of capital. Knowing how to calculate your company's runway could help you from running out of money.
For many startups, 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.
What is a cash runway?
The term cash runway means the time your business will remain solvent before depleting all cash reserves before needing to raise external funding.
Let's take an example; You are running an early-stage startup, and based on your calculations, you might say that you have a cash runway until the end of 2023. This shows that until the defined date, you would be able to keep the lights on, but after that, you would need a cash infusion.
Why is cash runway important?
Working in a business is like a rollercoaster ride, especially when running a startup. This is why you should know whether your business is stable or overspending. Being too lenient and not caring about the runway can lead you down the hill, and we know nobody would want that!
Many startup founders know that a short runway is indicative they should go for additional funding options or try to cut some unnecessary spending. However, if you have already received additional funding, even then, the cash runway is important as investors use it to track your profitability and growth.
How much runway is enough for your business?
This might be the first question that came to your mind after learning what cash runway is. The adequate cash runway amount depends on how you manage the cash.
Your main aim should be to boost profits with the current resources because your business might be breathing its last breath if you don't have enough revenue to cover the necessary expenses.
Generally, for startups, if the cash runway is two months or less, that's a bad sign. You can even keep the real-time measurement of the cash runway to stay stress-free and streamlined.
Burn rate analysis
Calculating your cash runway is not possible if you don't know the monthly burn rate. Burn rate is the pace of a company's expenditure. It is mainly calculated monthly but can be adjusted based on any period.
The burn rates are of two types-
- Net burn rate: A net burn rate is a monthly rate at which a company loses money. Its formula is given below.
Net burn rate = Cash/Monthly operating losses
- Gross burn rate: The gross burn rate is the total amount of cash you spend per month. This includes all the expenses like rent, salaries, supply costs, etc.
Gross burn rate = Cash/Monthly operating expenses
For example, If you earn $4,000 every month and spend $10,000, your Gross burn rate will be $10,000. On the other hand, your Net burn rate is $6,000.
How to calculate cash runway?
Now that you know the burn rate, you can quickly to calculate your cash runway. The formula for cash runway is:
To make it easier for you, here's an example; if a company has $50 million in the bank and its burn rate is $10 million per month, the cash runway period is five months before the company goes broke.
Different types of runway cash flow
A business uses its cash flow in multiple ways, and to get the most out of the runway cash flow formula, you must understand the difference between them.
There are majorly three areas of a company's cash flow:
- Company cash: The amount used to pay for daily expenses like rent and supplies comes under company cash.
- Team cash: The amount of cash used to pay the staff/employees are team cash.
- Founder cash: This is the cash that comes under the founder's savings, usually used to keep the business going.
Most businesses use company cash to calculate the cash runway, and they don't need to touch the team cash or founder cash, but still, if such a situation arrives, you can choose to pay employees with equity & non-cash incentives. Founder cash can also be used to save the company at the last moment.
How can you extend your cash runway?
Previously, raising additional funds was considered the most common way to improve your cash runway. But in present times, getting additional funding is complicated.
To be in a better position, you need other strategies. The following ways can help you with that:
- You can generate new revenue through higher sales. Try upselling/cross-selling or giving out offers to attract more customers and boost revenue.
- You can control your expenses and prioritize better capital expenditure.
- You can improve your accounts receivable management to boost cash inflow.
- Working from home has benefited a lot of firms. If you don't need the space, you can rent it to someone else and earn from it.
Ideally, you should aim for a runway of around 18 months.