As a startup manager, you know that understanding your cash position is critical to understanding how long your company can survive. One helpful concept to help you put this in context – and communicate it to investors – is runway. Runway is the amount of time your company can continue to operate at your current spending rate before running out of the cash you have. In this article, I’ll describe runway, how to calculate it, and how to use it to help make operational and financial decisions for your startup.
Think of your startup’s journey as a road trip. Before the trip, you know 1) how much fuel you have in the tank (cash on hand), which determines 2) how far you can drive (your runway), and 3) the most efficient way to get there with your available fuel (your business plan).
Once you depart, your route may change due to unforeseen circumstances, such as traffic congestion or construction roadblocks. Both unforeseen obstacles change how you use your fuel - so you’ll need to keep an eye on your fuel gauge (cash position) and determine whether or not the rate at which you’re burning fuel (cash burn rate) means that you need to stop for gas (raise money) before your car dies on the side of the highway (go out of business).
To get a better understanding of how much time you can operate with your available cash, you can use these three formulas:
Gross Burn Rate = Operational Expenses & Other Recurring Expenses
The gross burn rate of your business is a good place to start. This tells you how much money it takes to operate your business monthly. This would include payroll, utilities, rent and other overhead expenses. When taking a deeper dive into your income statement, you can separate which expenses are the key drivers of your overall monthly expenses.
Net Burn Rate = Gross Profit – (Operational Expenses + Other Recurring Expenses)
The net burn rate considers the revenue and the cost of your goods / services. If you are making $100,000 in revenue, spending $60,000 on inventory, and have a monthly operating cost of $50,000, your net burn rate would be $10,000 - meaning you are burning $10,000 of your cash reserves per month.
Runway = Cash On-Hand / Net Burn Rate
To determine your cash runway, divide your cash-on-hand by your net burn rate. If your business had a net burn rate of $10,000 and $120,000 of cash readily available, then your total runway would be twelve months.
Understanding these formulas is a critical component of business planning and will help you determine how effectively your business is currently operating.
When managing your startup’s runway, it is important to regularly review your financial statements to monitor trends of cash inflows and outflows. By doing so, you will be well equipped to make the necessary decisions to continue to grow your business and maintain good financial health. Like the car on a road trip, it is important to maintain a good level of fuel – you don’t want to wait until the tank is empty.
Founder’s CPA can assist with tracking and managing cash flow by setting up efficient financial systems, monitoring income and expenses, and forecasting cash needs for stability and growth. Reach out today to see how we can help!