Financial Runway and Burn Rate are crucial metrics for any startup founder as they help to plan ahead your financing efforts and avoid cash flow pitfalls. Both of them are measured in terms of time and money.
What are financial runway and burn rate?
A financial runway can be defined as the number of months or years that your startup can survive without the need to actively generate cash or raise additional funding, in other words, the amount of time a company has before it runs out of cash.
A burn rate is an important metric we need to figure out first in order to calculate our startup financial runway.
Here is the definition of Burn Rate according to Investopedia:
"The burn rate is typically used to describe the rate at which a new company is spending its venture capital to finance overhead before generating positive cash flow from operations. It is a measure of negative cash flow.
The burn rate is usually quoted in terms of cash spent per month. For example, if a company is said to have a burn rate of $1 million, it would mean that the company is spending $1 million per month."
Why financial runway matter to startup founders?
Every startup founder has a dream and a vision. What he doesn't have is time, money, or both. Whether you live on a shoestring budget or well funded by venture capitalists, it's a matter of time until you'll run out of money.
All businesses live on their cash coming in from clients, banks, investors, government support funding, etc. This cash finance the company activities such as inventory, R&D, sales and marketing, overhead and more.
During the first years of your startup, you'll experience cash-flow pitfalls, a temporary shortage of money, and unexpected expenses. You'll need to be very creative in finding ways to pass them through.
One way you can mitigate the risk is by being careful with your level of burn rate. As a founder and business leader, you need to know down to the dollar and day how much time you have till the next funding round.
How to come up with accurate calculation
The conventional way to control your income and expense level is through close management of budget plan and cash flow projection reports.
These are financial reports that will help you get a closer look at your cost structure, how healthy is your business, where is your main pockets of cash outflow, and how to plan your financing roadmap.
If you want to avoid costly mistakes and eliminate any numbers guesswork, you must maintain these reports on a monthly basis.
It's the only way you can get full transparency and confidence in executing your plans without significant setbacks.
Once you maintain a detailed budget plan, it will be easier for you to come up with an accurate financial runway and burn rate.
Burn Rate Calculation: -> is the average expense you incur every month. For example, let's assume the following monthly costs for a SaaS company:
SW Tools: $2K
Office Lease: $5K
Other Overhead: $7K
Total Monthly Burn Rate: $97K
Financial Runway Calculation: -> is based on all the cash resources that you have right now in your bank account/PayPal.
Plus, add all guaranteed cash inflow (from signed contracts or obligations, don't include any planned funding round or expected clients onboarding as there is no certainty for it).
Once you come up with the total cash you expect to have in the short term, all you need to do is to divide it by your monthly burn rate, and it will give you the financial runway in months.
For example: If all of my cash resources sum up to $970K and my monthly burn rate is $97K, that's means I have roughly 10 months of operation until I'll run out of cash.
What is the bare minimum of financial runway I need to keep for my startup?
I would say between 9-12 months is the minimum for a couple of reasons.
1. it sometimes takes more than six months to raise additional funding from new investors
2. it will help you to deal with unexpected expenses that can easily take 1-2 months out of your financial runway
3. you don't want to get to the red zone and get panicked, as people tend to make serious business mistakes when they are stressed
4. it's not good for your mental health
Free tools to help you calculate the financial runway like a pro
I've prepared a calculator for you that includes both burn rate and financial runway calculation.
I've equipped the calculator with a short training video that explains how to effectively use the calculator so you'll end up with accurate numbers.
Both of them are yours for free! Just click the button below, and I'll send them to your inbox.
Financial Runway and Burn Rate are essential metrics for any startup founder, no matter if you're just getting started or five years down the road.
Make sure you have handy calculations you can track every month and apply the necessary adjustments, as reality is more reliable than any past projection.
Use the tools I've built for you, and it will make it easier for you to come up with accurate numbers.
If you have any questions, let me know in the comments sections below.