Image Credit: Y Combinator
Cash is king when building businesses - You have probably heard that phrase before. So have we, and it's probably because there's some truth in it. Yet despite most founders knowing the importance of tracking money, 29% of companies fail because they run out of cash.
It's time to rethink cash and ensure you know it inside and out.
This brings us to the understanding of a runway. Whilst a physical runway often is something you know as the area where a plane takes off, it is actually quite similar to the "runway" in financial terms.
Effectively, a runway answers just one question: How long can your company survive?
Now, let's break it down into more understandable terms. Let's imagine a company Acme Inc. and consider this example:
- Acme Inc. has raised $1,000,000 in seed funding from investors.
- They are spending $50,000 per month on salaries, office, servers, and equipment.
- They are currently not generating any revenue. Hence, both their net burn rate and gross burn rate equals $50,000/month.
- Therefore, Acme Inc. has 20 months of runway left until they either need to raise another round of funding or generate enough profit to pay their operating expenses.
How Do You Calculate Your Runway?
Here is our step-by-step instruction on how to do it.
1. Understand your cash balance
Find your cash balance at the start of a given period, let’s say that Acme Inc. had $1,000,000 in the bank on November 1st, 2020.
2. Find your burn rate
Now, look at the ending cash balance, for instance, one month later - in this case, December 1st, 2020 - and let's say it was $950,000.
As a result, we can find our burn rate, which is calculated as:
Burn rate = Starting Cash Balance - Ending Cash Balance
Which is in this case: $1,000,000 - $950,000 = $50,000
Pretty simple, right?
3) Calculate your runway
Now that we understand Acme’s burn rate, we can easily calculate the runway by dividing our current cash balance by our burn rate
Runway = Current Cash Balance / Burn Rate
Acme’s Runway (in months) = $1,000,000 / $50,000 = 20
How Can You Optimize Your Runway?
Having more runway than you need is always helpful in making day-to-day decisions about your start-up. Imagine you operate with 3 months of runway, then you would need to constantly chase investors to raise more capital… Not dreamy. Most startups aim to have between 12-18 months of runway between each round of fundraising. This gives enough room to hire people, build products, and raise more capital before running out of cash.
There are several ways you can follow to optimize your runway and burn rate and here are a few of the best ones.
4 ways to optimize your runway
1) Decrease your software costs
If you’re spending thousands of dollars a month on software services, have a deep look into which ones can be removed, or downgraded at least. More often than not, you will find that you can find cheaper alternatives to most of your providers.
2) Find deals on software services
3) Don’t spend money on rent
If you’re still a small startup of 5-10 people, consider letting people work from home (as most people do right now anyway), or hustle your way to a free office. Quite often, larger companies can easily find a little corner for 5-10 people, which, if they like you, and believe in what you’re doing, they may offer you for free. If you’re a software company and building a tool that could be useful to them, you can easily exchange your software for free desks. The additional benefit of this is that you immerse yourselves in an environment with more likeminded people who can give you feedback on your product.
4) Implement tight expense policies
If each employee has their own corporate card, implement a spending policy that clearly outlines how your company spends money. Note that employees often can get frustrated if you implement too many rules on their spending, so it’s really important that you communicate the bigger picture to them, and actually go ahead and explain to them your current burn rate and runway, and how much their savings mean to the wellbeing of your company - it’s all about ensuring mutual alignment.
How Often Should You Monitor Your Runway?
Y-Combinator, the world-famous startup accelerator, that invested in companies like AirBnB, Stripe, DoorDash, and many more, suggests that founders need to track their runway at least every week in order to constantly stay on top of it. Learn more about startup finances in this video by YC partner Kirsty Nathoo.
How Can You Monitor Your Runway with Ease?
Manually calculating your runway and burn rate every week can be quite tedious and time-consuming, so that’s why we built LiveFlow.
LiveFlow connects to your bank account and automatically gives you a crisp dashboard with a real-time overview of your cash balance, burn rate, runway, and more.
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Sign up here to track your runway in real-time.