Every business, especially new startups or quickly growing businesses, should be keeping a close eye on their cash burn and runway.
These metrics provide essential insight into the sustainability of your spending habits and the financial health of your business. If cash burn and runway are struggling, your business will also struggle.
Below is an overview of what exactly cash burn and runway mean for your business and how you can manage them.
What is Cash Burn?
Cash burn is a measure of how quickly your business uses your cash balance. In other words, cash burn is the measure of how much cash is flowing out of your business.
Typically, cash burn is measured on a monthly basis. However, in some cases, when the need to use cash increases, it can be measured on a weekly or even daily basis.
Why is Cash Burn Important?
Cash burn rate is a great indicator of the overall health of your business. It shows you:
- How long you have until you run out of cash
- If you have a healthy cash flow
- How fast you are spending the money you have on hand
It’s important to find a healthy cash burn rate. In fact, a recent study shows that nearly 82% of businesses fail because of cash flow problems.
If you are spending your cash too quickly, it can lead to a failed business. If you aren’t spending your cash fast enough, it can indicate a lack of growth and investment in your business.
For young businesses and startups, cash burn is especially relevant. Typically, profits are low during this time, which means managing your spending is even more important.
How to Calculate Cash Burn
Cash burn for any given period of time is fairly easy to calculate. First, you have to identify your start and ending cash balance (found on your statement of cash flows) and then find the difference between those numbers. Next, you divide the difference by the number of months in the given period. The total is your monthly cash burn rate.
Here is an example:
$300,000(starting balance as of Jan 1) – $120,000(ending balance as of March 31) = $180,000(difference)
$180,000(difference) / 3 (number of months in the period) = $60,000 monthly cash burn rate
Now that you know how quickly you are going through your cash, you need to determine how long you can withstand that spending rate. This is referred to as your runway.
What is Runway and How is it Calculated?
Runway is the amount of time your business can continue to operate with your current cash burn rate. Like burn rate, a healthy balance of runway is essential for any business.
If you have a short runway, your business is quickly running out of time to survive. However, while a long runway sounds appealing, it could also mean you are not properly allocating your cash reserves.
To calculate your runway, simply divide your total cash reserve by your burn rate.
$120,000(total cash reserve) / $60,000(burn rate) = 2 months left before your business runs out of cash.
Tips for Managing Cash Burn and Runway
Ideally, your business will have a negative cash burn rate. This would indicate that you are bringing in more money than you are spending and would, therefore, lengthen your runway.
Here are several proven ways to manage your cash burn and runway:
1. Reduce or Defer Non-Essential Expenses
You’ll want to take a close look at your budget to determine if your expenses are bringing value to your business.
Find where you can cut, reduce, or defer certain expenses. However, make sure your changes are sustainable. Making too many changes too quickly can stunt growth.
2. Pay Bills Slower
If you aren’t reaping a benefit from paying your bills before they are due, hold off on your payments.
This allows you to hold on to your cash for longer periods of time.
3. Bill Sooner and Collect Faster
If you’re struggling with your cash burn and runway, one of the best adjustments is collecting your money sooner rather than later.
Send your invoices right away and include terms for payment. If you’re struggling with collecting payments in general, try implementing a late fee or improving your collection methods.
4. Raise Additional Funds
Many new start-ups and small businesses have to go through multiple rounds of funding before they start seeing substantial profits.
After calculations, if your cash burn and runway are not where you want them to be, consider raising additional funds.
5. Increase Prices
Inaccurate or low prices can negatively impact your profits. If you’re looking for more cash inflows, consider running a pricing analysis. Chances are, you’re charging too little for your products and/or services.
Our Free Cash Flow Tool Can Help
Having clear predictions of your cash burn and runway can mean the difference between success and failure for your business.
That’s why we put together a free cash flow tool that lets you plan your budget in advance and see how much money is coming in and out of your business over time.