Startup Operation – Calculate Burn Rate and Runway
As we all have heard repeatedly in finance classes, Cash is king! This quote rings truer than ever in the fast and furious place we call, the startup world. Founders are usually racing against the clock to survive and succeed. One of the key components to succeed in the startup world is cash! Cash is the king and it determines the runway of the business.
So how do you get to your company’s burn rate and runway, you may ask? After successfully raising your funding, you now have the investment cash sitting in the bank. With the cash in hand, the next step is for founders to know their burn rate and runway. The calculation is not complicated, in fact, it is actually really simple, yet so important. Here are the top five things you need to know about your burn rate and runway:
1. What exactly is burn rate?
In a simple term, burn rate is how much your startup company spends in a month. Burn rate indicates that, without any income, how much you need to have in the bank to keep your company running monthly. So, understanding your burn rate at all time is very important, so you won’t have surprises.
2. How to calculate burn rate?
Burn rate = cash ending balance - cash opening balance of the same month
For example, say that your company has one bank account only, on Jan 31st you open with $0.9M, and on Jan 1st you end with $1M. This makes your burn rate for the month $0.1M.
CFO tip: It is recommended to use multiple months of data to calculate your burn rate, so that you will get an overall average. The average burn rate is a more accurate indicator for your monthly spending, and smooths out the fluctuation from month to month. Try use the data from three consecutive months to calculate the burn rate, it is a more accurate indicator.
3. What is runway?
Runway is the number of months your startup can survive without any additional funding.
4. How to calculate runway?
Runway = Total cash in the bank ÷ Average burn rate
Let’s continue with the example from above, your average burn rate is $0.1M and the total cash in the bank this month is $0.9M. Your runway is $0.9M ÷ $0.1M which is equal to 9 months. You have 9 months to either raise the next round of funding, start generating enough income to cover your monthly spending, or the worst-case scenario, go bankrupt.
CFO tip: Plan ahead and plan often. Knowing the number of months your startup can sustain without any additional funding pushes you to look over the spending and focus on increasing the sense of urgency. Founders need to make a budget to increase the spending on the areas that yield to profits, and cut the spending on the areas that are not profitable.
5. How often do you need to calculate these two rates?
CFO tip: Most startups do it on a monthly basis, right after they close last month’s accounting books.
Conclusion:
Burn rate and runway are the two numbers that investors ask for the most, and are also the numbers that keep founders awake at night. Being able to use burn rate and runway accurately is definitely a skill founders should possess. Again, cash is the king, founders need to plan ahead and plan often.
