A Founder’s Survival Metric: How To Calculate The Cash Runway Accurately

How to calculate the cash runway accurately is a founder skill crucial to a startup’s survival. This metric indicates the number of months an early-stage company can continue operating without raising external capital.

On the other hand, if you’re planning further fundraising for your later-stage company, potential investors will scrutinize your cash runway. These numbers indicate capital efficiency and whether you’ve met the projected milestones following the last capital raise.

Thus, the runway can influence the success of your fundraising campaign at any stage of business growth.

Understanding What Cash Runway Is

You’ll determine the cash runway in terms of the number of months’ worth of liquid cash available in the company. Consider it a financial countdown, and the time period during which the company can continue operating before a cash infusion. That is, external capital or additional revenue.

When calculating this metric, you’re assuming that the company won’t incur any future deficits or unexpected expenses. In a nutshell:

Cash runway = current cash balance ÷ burn rate

Note that the current cash balance is the liquid cash you have available. Or the money you can access within a maximum of 30 days. Whether you calculate the metric in months or years, the result will provide a precise view of the runway.

Essentially, you’re measuring income and expenses for the targeted period. The crucial metric here is the burn rate or costs. When understanding how to calculate the cash runway accurately, you should also know how to calculate the burn rate. This is the amount the company spends each month.

The Difference Between Cash Runway and Burn Rate

The cash runway and burn rate are crucial metrics since they quantify how the company utilizes cash. The runway, though, goes one step further than the burn rate. This figure shows how long you can continue operating before your cash reserves are exhausted. Here’s what you need to know.

Calculating Expenses

The burn rate indicates how much capital is required to sustain operations. You’ll include expenses, such as salaries, rent, inventory, product development, advertising and marketing, and more.

Next, you’ll divide expenses by the number of months required for the metric, typically 12 to 18 months. Don’t forget to factor in annual expenses, such as software subscriptions, professional and legal fees, taxes, and insurance. Divide the number by the runway period and add it to the burn rate.

Calculating Gross Revenue

When calculating revenue, you’ll calculate the total number of units sold multiplied by the price per unit. Also, factor in any discounts and returns. Next, you’ll include additional income from sources unrelated to product sales. For instance, leasing the premises, equipment, or tools.

The revenue list will also include the cost of products sold on credit. Your financial statement will reflect an accounts receivable entry, which increases every time you make a sale. When payments are realized, you’ll transfer them to the revenue calculation.

Revenue calculations also depend on the sector in which you operate. For instance, say the company sells SaaS applications that customers can subscribe to. In that event, your revenue includes monthly, quarterly, half-yearly, or annual subscription fees.

If you offer customers the option to cancel subscriptions, you’ll only include the actual fee for the runway time interval. If that option is not available, divide the fee by the number of months.

Calculating Burn Rate

If your expenses total $700K per month and the company earns almost no revenue, that’s your burn rate. However, if the company earns $400K in revenue each month, you’ll deduct it from expenses. The resultant burn rate is thus, $700K – $400K = $300K.

When figuring out how to calculate the cash runway accurately, many founders rely on the cash flow statement. Accordingly, the formula they use is:

Burn Rate = Opening Cash Balance – Closing Cash Balance / Number of Months

However, to get accurate results, you’ll select a longer time interval. Company operating expenses typically fluctuate month over month, and shorter time periods may not reflect the total costs. For instance, you could spend $150K in the first month when setting up the operational infrastructure.

In the second month, your expenses could drop to $30K. In the third, you spend an additional $40K to purchase inventory, which will be required for the next six months. Unless you calculate average expenses over a more extended period, such as 12 months, the results will be inaccurate.

Understanding Gross Burn Rate and Net Burn Rate

When investors review your pitch, they may focus on both — the gross and net burn rate. The gross burn rate assumes the company has no revenue and includes your month-over-month operating expenses. Accordingly, your average monthly expenses are your burn rate.

However, the net burn rate also accounts for the revenue the company earns and rolls back into operations. Accordingly, the net burn rate is the difference between expenses and revenue, averaged over the runway time interval.

How to Calculate the Cash Runway Accurately for Venture-Backed Companies

If your company has successfully raised a funding round, the cash infusion can influence how you calculate the runway. Here’s what happens.

You’ll start by determining the company’s cash balance at the start of the runway period. Let’s assume that company ABC has $1M in the bank. It raised $2M in funding, bringing the total to $3M. The company ABC now has $3M in cash reserves.

As the company continues operating, by the end of a six-month period, it is left with a $1.5M balance. To calculate the burn rate:

Net Burn Rate = Cash Balance / Number of Months

This figure works out to $1.5M/6 = $250K in net monthly burn rate.

Further, $1.5M (cash balance) / $250K (burn rate) = 6 months of startup runway.

Based on this calculation, company ABC can continue operating for up to 6 months. Within this interval, it must raise a fresh capital injection. Alternatively, it must significantly increase revenue to remain operational.

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Typical Challenges to Calculating Startup Runway Accurately

Calculating the startup runway and arriving at accurate figures is a complex task and involves several variables. In addition to compiling and tracking metrics, founders must manage the day-to-day challenges of running the company. However,. Don’t make the mistake of losing track of the finances.

Prioritize and set aside time to stay on top of the company’s reserves. Always remember that raising funding is a time-consuming process that requires time and bandwidth. The time taken to reach out to investors and get money in the bank depends on several factors. Your growth stage is one of them.

Here are some of the other hurdles you’ll likely encounter:

• Early-stage startups have yet to establish a dedicated customer base, achieve consistent sales, or reach ideal product-market fit. As a result, their revenue is inconsistent, making it harder to calculate burn rate or runway. Their projections are also inaccurate and erratic.
• When startups are still finding their feet, they’re unsure about their overheads and other costs. This factor can also affect calculations, as predicting inputs is challenging.
• Regardless of the company’s growth stage, it will likely incur unexpected costs due to shifting market conditions. It must also address legal fees, equipment breakdowns, product returns and repairs, and other expenses that increase the burn rate.
• Anticipating the exact timeline for successful fundraising is a significant hurdle. Running out of cash before a capital infusion is the reason why 28% of companies fail.
• Customer churn rates are unpredictable, and many companies face difficulties with customer retention. Key deals falling through during negotiations can significantly impact the runway.
• Many companies have seasonal product categories, such as summer and winter clothing. Or, products related to a specific holiday season, such as home and yard decorations.
• Durable products such as electronics and vehicles typically have long sales cycles.

Where Founders Go Wrong When Calculating Runway

As long as the startup is in its early stages and not yet generating revenues, you’ll rely on projections. These estimates are based on metrics and data from similar-sized companies in your sector or producing comparable products. But once the company is more stable, you’ll rely on internal data.

Remember that every company is unique, and the benchmarks that work for others may not work for you. Further, a growing startup evolves quickly, and the projections you relied on earlier might no longer be relevant.

Your expenses and budget may increase month over month as you scale the company. For instance, you’ll hire and onboard fresh talent and invest in research and development to refine the products. You may also relocate operations to new premises or transition to a more cost-effective vendor.

Marketing campaigns, customer acquisition programs, market research, and logistics — these are only some of the expenses you’ll incur. This is why it’s crucial to shift from industry-specific historical data to real-time metrics sourced from within the company.

When learning how to calculate the runway accurately, understand that projections from comparable companies cannot account for the decisions you make for your company’s future or its mission statement. It’s advisable to rely on applications that deliver month-over-month numbers in real time.

Always rely on up-to-date data compiled from multiple company accounts, such as credit cards, bank accounts, and billing platforms. Also, track how long it takes for a sale to convert into real revenue that appears in the company’s accounts. Unpaid and outstanding invoices can influence the runway.

Your objective should be to gain a precise view of how cash and transactions flow through the company. This initiative is crucial not only for reassuring investors but also for ensuring the company doesn’t run out of liquidity.

Do you have more questions about what is cash burn rate? Check out this video in which I have clarified some of the typical doubts entrepreneurs have.

Calculating Runway for Capital-Intensive Startups

Capital-intensive, high-growth startups typically require substantial funding and time before they can begin generating revenue. These sectors include biotech (pharmaceuticals and healthcare), oil and gas, renewable energy, and artificial intelligence and machine learning, among others.

Investors recognize the significant opportunity for rich returns, which is why they are willing to back such companies. That is, if the business idea and plan demonstrate adequate potential. Such startups typically need multiple rounds of venture support before they can deliver returns.

They are likely to allocate the capital they raise to building products and infrastructure that generate profits over time. In these cases, burn rates and startup runways have entirely distinct connotations.

For instance, if the company’s burn rate is cautious, that may indicate sluggish growth. Investors may lose confidence in the founder’s leadership capabilities and risk-taking to achieve accelerated growth.

Venture capital firms need to see returns quickly and may hesitate to participate in future funding rounds. They typically have a fixed investment horizon and must deliver returns within a defined timeframe.

On the flip side, if the company’s burn rate is too high, it could indicate a lack of cost efficiency. This is again a downside, and investors may doubt the founder’s ability to manage operations profitably. Their focus will be on whether the company successfully achieves its projected milestones.

Thus, capital-intensive startups must strike the right balance between aggressive and cautious capital spending to reassure investors.

In Conclusion!

Your company’s ultimate success or failure hinges on your knowing how to calculate the cash runway accurately. Ensure you leverage real-time data to gain complete visibility and clarity into its financial status. Updated data will enable you to make informed decisions for its continued stability.

You’ll pivot and adapt based on liquidity availability and take the necessary steps to extend the runway. Running out of cash can spell disaster for a company, especially given that raising capital is time-consuming.

Investors are more likely to back a founder who demonstrates business acumen and leadership qualities. They appreciate entrepreneurs who can keep a firm hand on the company’s expenses and runway. Capital efficiency and the ability to reach milestones attract capital and investors.

Rely on the assistance of an expert fundraising consultant who can guide you in the right direction. You can leverage their expertise to calculate the runway and the funding required.

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