Running out of cash is one of the most common reasons startups fail. That’s why managing cash is such an important aspect of building momentum to get your startup off the ground.
With any business, in the early stages especially you’re likely to have way more cash going out than coming in.
Knowing your burn rate and how much runway you have left is critical for keeping your startup from going under.
Burn Rate – What is it? And How is it Calculated?
There are two ways of looking at burn rate:
- Gross burn rate: total cash spent each month
- Net burn rate: the difference between cash in and cash out. Or, gross burn rate minus cash in
Let’s take a closer look.
Gross Burn Rate
A simple method of determining your gross burn rate is to add up all of your monthly outgoing expenses.
Let’s say, for example, you have a small SaaS startup. To bring your product to market you’ve hired three developers ($17k in monthly salaries), rented a small office ($1.5k per month) and some furniture and IT equipment ($1.5k per month).
Gross Burn Rate = -$20,000 = -$17,000-$1,500-$1,500
In total, your startup is burning through $20k a month.
Net Burn Rate
Let’s take the same example and assume a gross burn rate of $20k each month.
But, you’ve had some success and won your first customers, generating around $8k month in revenue (and cash in). This cash-in puts your net burn rate of $12k.
Net Burn RAte = -$12,000 = -$20,000+$8,000
Although you’re still spending $20k per month, the cash in reduces the drain on your bank accounts and helps the business stay afloat longer.
What’s the Relationship Between Runway and Burn Rate?
Knowing your burn rate is critical for determining your runway. Similar to an airplane taking off, runway refers to how much cash the business has left to get off the ground.
In other words, runway is the amount of time the business can continue to operate without securing additional funding.
Imagine that you have $180k in cash remaining.
Before the cash is gone, you’ll need to reach break even. If we factor in only your gross burn rate, you’ve got about 9 months left to rev up your sales to the level of your expenses.
Runway = 9 months = $180,000 / $20,000 Gross Burn Rate
If you consider net burn rate, you’ve got around 15 months of runway left.
Runway = 15 months = $180,000 / $12,000 Net Burn Rate
Normally, net burn rate is the preferred calculation because it shows how long you have left at your current rate of cash consumption.
However, it might make sense to use gross burn rate to determine your runway, depending on the nature of your revenue. If your revenue is unsteady, $8k one month, $0 the next, or coming only from one customer, it will be hard to make a reliable calculation.
Is a High Burn Rate Bad?
The short answer is: it depends. A high burn rate isn’t inherently bad. Different companies and business models require different levels of activity to get them off the ground.
If you suspect that your burn rate is too high, it might help to get advice from a finance professional who specializes in startups (like Pasquesi). They’ve likely seen different business models and can give you some perspective both on your burn rate and on what you can do to extend your runway.
How to Lengthen Your Runway
A longer runway means you have more time to generate positive cash flow, more breathing room. If you’ve got a high burn rate, limited runway, and no major cash influx on the horizon, it’s time to take a critical look at reducing your burn rate.
There are two paths to extending your runway:
- Lower operating costs
- Higher revenue
Higher sales is typically the preferred path. But, sometimes reducing operating costs is necessary.
There are a few ways to go about this, but it’s most often accomplished by:
- Reducing payroll through layoffs or reduced working hours
- Moving to a small or less expensive office space
- Cutting back on other expenses
At a startup, it’s especially critical that your employees are pulling their weight and are a great fit for your company culture. Salaries make up a majority of a startup’s operating expenses and can add up quickly.
Getting the right team in place is key for ensuring your startup’s success. It’s not uncommon for tenures to be shorter at the beginning.
Even if your current cash situation isn’t critical, keeping your expenses and burn rate low can set you up for success:
- Focus on outsourcing or hiring interns (where possible)
- Don’t rent the biggest, most expensive office space
- Don’t take on more equipment than necessary
Optimize Your Startup’s Finances
Startups, especially in the early stages, need to stay vigilant about their cash position and remaining runway.
Pasquesi is an accounting service specializing in startups and small businesses. We’ve shown you a few things about how to calculate and extend your runway on your own. If you’d like some actionable advice on optimizing your startup’s runway, set up a call with our startup experts. We’d love to hear from you.