March 7, 2022 by Adam Hoeksema
In finance, the cash runway, or business runway, is a term that refers to the number of months a business can operate or sustain itself before it runs out of money.
In other words, it specifies the number of months a company can operate at a loss, without generating any profit, before it liquidates.
For example, a startup might state that it has a cash runway of 14 months. This statement means that the business will be able to operate for 14 months without generating a profit before it exhausts its cash reserves and will no longer be able to fund its operations.
To continue operations beyond those 14 months, the startup would need to extend its cash runway by raising additional capital or cutting operating costs.
Another term that we encounter when discussing the cash runway of a business is the burn rate. Both the cash runway and the cash burn rate are useful KPIs for owners, investors, and other stakeholders.
Difference between Cash Runway and Burn Rate
While the cash runway is the number of months a company can operate at a loss before it folds, the cash burn rate refers to the rate at which a company spends or loses money.
Your burn rate tells you your negative cash flow, and in most cases, a company's burn rate is used to calculate its runway.
If the business runway is a physical airplane runway, then the burn rate is the yardstick for measuring it. There are two types of burn rates business owners need to consider:
- The gross burn rate: measures how much cash you spend each month on all operating expenses, including rent, utilities, supplies, machinery, and salaries. It does not take the company's income into account, only expenses.
- The net burn rate: measures how much cash you lose each month, taking into consideration both income and expenses. If your cash outflow is greater than your cash inflow, then you are burning cash.
Typically, a startup will have three types of cash to deal with:
- Company Cash: The cash a company uses to pay its operational expenses,
- Team Cash: The money paid for salaries. Founders may tap into this by offering employees equity or non-cash incentives instead of cash, and
- Founder Cash: The startup founder’s personal cash reserves that may be used to run the startup if the company cash is low.
Why It Is Important to Know Your Cash Runway
The cash runway is an important metric that every founder must monitor and for good reason.
Your runway can provide insights into your company’s growth and profitability and will indicate whether you are overspending or within a safe range.
If your runway for a recent quarter decreases compared to the previous quarter, it indicates that you are overspending or your income has decreased, or both.
While a long runway is vital for businesses of varying sizes, it is even more important for startups because investors and other stakeholders will closely monitor this metric.
Startups tend to have shorter runways and correspondingly higher net burn rates than established businesses that are already profitable.
Monitoring the cash runway is also essential because it lets you know when to seek additional funding options or cut costs to lower the gross burn rate so your business can remain solvent till the next funding round.
Not monitoring your business runway, especially if you are just getting started, is very risky as you might run out of cash to support the business when you least expect it. In this case, you may need to start funding the business with the team cash or your own cash reserves—a move that can significantly lower the chances of a business becoming successful or receiving additional funds from investors.
Seasonal businesses can also leverage their cash runway to determine what margins are comfortable since they may see a shorter runway during the slow season and a longer runway during the busy season.
Finally, you can determine whether a startup is “default alive” or “default dead,” depending on what is left of its runway. And keeping a close watch on the cash runway can help founders and stakeholders make necessary decisions to keep a company alive when times are tough.
To be default alive means that a startup is growing and is on the right track to turn cash flow positive before the end of its runway. Default dead means that a startup will run out of money before it becomes profitable.
To calculate whether your startup is default alive or default dead, you need to analyze critical aspects of the company’s finances:
- Cash balance
- Current revenue
- Current growth rate
- Current expenses
We can use a fictional tech startup, Correx, to understand how these factors determine the default state of a company. Correx currently generates $2931 in monthly revenue, has $66,100 in fixed monthly expenses (gross burn), is growing at 10.5% per month, and has $2,010,493 in the bank.
Without its monthly revenue, Correx will burn through its current cash balance in 30.4 months. And at a 10.5% monthly growth rate, it will take the company 32 weeks to reach profitability, with week 32 bringing in roughly $71,550.40—a profit of approximately $7,514.
During the 32 weeks it will take Correx to reach profitability, the company will spend $2,115,200 on fixed expenses but only make about $653,516.40 in revenue. This scenario leaves a deficit of $1,461,683.60.
At its current rate, if Correx has less than $1,461,683.60 in the bank, it will run out of cash before reaching profitability. Thus, the business is default dead. But Correx has $2,010,493 in the bank and so will cross the profitability mark without running out of cash. Therefore, it is default alive.
Clearly, Correx's cash balance ($2,010,493) is not large enough to sustain it to profitability at its gross burn rate. But its revenue of $653,516.4 is part of the company cash and is added to its cash balance.
How to Calculate Your Business Runway
The business runway can be projected using the burn rate or forecasts. However, the burn rate provides the most accurate results.
How to Calculate Cash Runway Using Burn Rate
While you can calculate your runway using company figures that span several years, figures from the past month or quarter will suffice. If you choose to calculate for the past month and the past quarter separately, you may get different results depending on how your spending has changed.
The cash runway formula is
Cash Runway (CR) = Current Balance (CB) ÷ Burn Rate (BR)
Continuing with the example of Correx, our fictional startup above, here is how to calculate your business runway.
- Find Your Net Burn Rate
You can find your net burn rate by subtracting your starting cash balance from your ending cash balance and dividing it by the number of months. For Correx, we are calculating using three months of data.
Starting cash balance = $2,200,000
Ending cash balance = $2,010,493
Months = 3
Net Burn Rate = (Starting Cash Balance - Ending Cash Balance) ÷ Months
NBR = ($2,200,000 - $2,010,493) ÷ 3
NBR = $189,507 ÷ 3
NBR = $63,169
After all expenses and income are totaled, Correx is losing, on average, $63,169 each month. That is its net burn rate.
- Calculate Your Cash Runway
Now that you have all your numbers, you can calculate your runway by taking your current cash balance and dividing it by your average burn rate.
With $2,010,493 in the bank, how long can Correx survive without funding or profit?
Remember the cash runway formula: CR = CB ÷ BR
CR = $2,010,493 ÷ $63,169
CR = 31.82 months
Correx has a runway of almost 32 months to play with—a very healthy figure for a tech startup. At its net burn rate, the current cash balance should sustain the company until the next funding round or until it breaks even.
Remember the figures earlier, when we projected Correx's journey to profitability?
The difference between these calculations is that the business runway is projected using performance data from the past; in our case, the previous quarter, while the company's journey to profitability is projected using "expected data" into the future.
Now, assume Correx's growth falls from 10.5% to 8% after a few months, and, consequently, it can no longer make a profit at week 32. The company has enough runway to get it past the next funding round. This illustration demonstrates why it is crucial to regularly calculate the state of the company (alive or dead by default) and its runway, as these metrics can inform decisions on spending.
More on funding rounds later.
What Is a Healthy Cash Runway?
How much runway is good varies from company to company and is dictated by different factors. But since most early-stage startups count on progressing through the fundraising rounds rather than revenue and seed capital alone in their growth stage, it is only logical for founders to aim for having enough runway to last them until the next fundraising stage.
There are a lot of recommendations and plenty of information scattered all over the internet concerning how much runway is enough and how much time-lapse is often between funding rounds.
A Google search will provide multiple sites suggesting that the cash runway should be anywhere between 12 and 18 months. And on Quora, you will with no doubt find answers that confirm 12 to 18 months to be enough runway for any startup at any stage. There is data to support this popular opinion.
Not long ago, CB Insights analyzed its data to determine the median number of days between different equity rounds for tech companies.
Studying CB Insights' data, we found that the time-lapse between Seed and Series A funding is the shortest—a median of 11.3 months.
The time-lapse between Series A and B funding is a bit longer—a median of 16.15 months.
And the time-lapse between Series B and C financing was even longer—a median of 18.5 months.
Based on this data, it is evident that a company will need to find ways to extend its runway at each funding stage. In other words, if your runway was 12 months to Series A, you will need a longer runway to reach Series B.
However, a more recent venture capital funding data analysis published on StartupFIU reported a trend that differs from the one on CB Insights. The source of the data for this analysis is Crunchbase.
According to this analysis, the average time-lapse from Seed to Series A funding is 18.1 months, while the median time-lapse is 15.0 months.
The figures increase until the lapse between Series B and C funding, which records the highest average time-lapse of 22.0 months and a median lapse of 19 months. And the lapse from Series C to D trails just behind it with an average time-lapse of 21.7 months and median lapse of 19 months as well. After this, the numbers go down.
Judging by the overall results with an average lapse of 20.6 months and a median lapse of 18.0 months, we recommend that startup founders should strive to maintain at least 18 to 21 months of cash runway to increase the chances of keeping the business afloat. It is always better to give yourself plenty of wiggle room when assessing your business runway.
8 Ways to Extend Your Cash Runway
You can extend your cash runway by increasing your revenue, cutting your expenses, or both. Below are eight strategies you can adopt to do these:
- Discourage Credit Sales
In other words, encourage cash sales. You can increase your cash balance faster if you can get more customers to pay in cash rather than invoicing them at a later date.
- Delay Bill Payments
Delaying bill payments may not be an ideal move, but it is a better option than bankrolling a company with the team or founder cash. Besides, this strategy can keep your cash balance temporarily higher.
If there are no incentives for early payments or penalties for late payments, then there is no reason to pay bills earlier than necessary.
- Negotiate Lower Costs with Vendors
Open negotiations with your vendors, especially the ones you patronize more often and discuss ways you can get more supplies for your money. A lot of the time, vendors would rather compromise than lose you as a customer.
- Find Ways to Boost Sales
There are several ways you can boost sales and revenue without raising prices or spending more on marketing.
You can experiment with different pricing tiers by offering a less functional version of your product for a lower price or offering various payment packages, including weekly, biweekly, monthly, quarterly, semi-annual, or annual payments while maintaining your product’s integrity.
You can upsell and cross-sell to current customers. You can reignite conversations with sales-qualified leads (SQLs) and retarget your ads to marketing-qualified leads (MQLs).
You can also offer discounts to SQLs and MQLs on purchases up to a certain amount.
You can run clearance sales to sell excess inventory. You can sell extra inventories to companies that might need them as supplies, etc.
- Cut Nonessential Expenses
Not all expenses are essential in running your startup effectively.
Ask yourself: Do I really need that spacious office space in the city, or can I switch to a hybrid- or remote-work model to save on rent?
Will I benefit from outsourcing some work instead of hiring in-house teams to save on employee benefits and associated administration fees?
Can some tasks, like payment collection and appointment booking, be automated rather than making new admin hires? Or should I even put a hold on hiring for the next few months?
- Delay Major Purchases
If the company reserves are running low and your runway seems to be shrinking, you may need to place a hold on any significant expenditures you have planned. An exception, of course, is an investment that will start generating revenues immediately or in the near future.
- Raise Additional Funds
If your next funding round is not yet in sight and your cash balance is too low to sustain the company for long, consider government-backed loans and grants that can provide extra cash to extend your business runway.
While loans are almost always available and approvals are typically fast, grants are not immediate and may take several months for approval—provided you qualify. So grants are something you should keep your eyes on as early into the business as possible.
- Put Nonrevenue-Generating Offerings on Hold
If your startup has offerings that are not bringing in money yet, you may consider putting those on hold to save on their production costs while you focus on the product(s) with the highest potential for success.
The cash runway is a metric that can inform your decisions in spending cash and keeping your business alive by default. It is also a metric that investors use to gauge the growth of a startup and its spending habits.
Being aware of your runway and keeping it high is just as important as sourcing for finance.
Let us help you at ProjectionHub to build a financial model that can help you understand your projected runway so you can plan better!