What is Cash Runway and Why is it Important?

Introduction

Cash runway is a term that refers to the amount of time a business can stay in operation before running out of money. It is calculated by dividing the company's current cash balance by its burn rate, which is the amount of money it is spending each month. For example, if a startup has $100,000 in cash and a burn rate of $10,000 per month, its cash runway would be 10 months. Cash runway is a crucial metric for startups and small businesses, as it can help them determine whether they need to find additional funding or cut expenses in order to stay afloat.On the other hand, a startup with a longer cash runway has more time to focus on growing its business and increasing revenue.

In addition to helping businesses stay afloat, understanding and managing cash runway can also help startups be more strategic in their fundraising efforts. By knowing their cash runway, startups can be more targeted in their efforts to secure additional funding and avoid running out of money before they are able to secure the funding they need.

Overall, cash runway is an important metric for startups and small businesses because it helps them understand their financial health and make informed decisions about how to manage their finances. By understanding and managing their cash runway, startups and small businesses can position themselves for success and avoid financial challenges that could threaten their viability.

Formula for calculating cash runway

The formula for calculating cash runway is relatively simple:

Cash Runway = Current Cash Balance / Burn Rate

The current cash balance refers to the amount of money a business has available to it at a given time. The burn rate is the amount of money the business is spending each month. By dividing the current cash balance by the burn rate, you can determine how long the business can stay in operation before it runs out of money.

For example, if a startup has a current cash balance of $100,000 and a burn rate of $10,000 per month, its cash runway would be 10 months. If the burn rate increases or the cash balance decreases, the cash runway will also decrease.

It's important to note that there are two types of burn rate: gross burn rate and net burn rate. Gross burn rate refers to a company's total operating costs, while net burn rate takes into account revenue and profits. For example, a startup with a gross burn rate of $30,000 per month and revenue of $20,000 per month would have a net burn rate of $10,000 per month. The type of burn rate used can affect the calculation of cash runway, so it's important to understand the difference between the two.

‍

Gross burn rate vs. net burn rate

Gross burn rate and net burn rate are two terms that refer to the amount of money a business is spending each month. Gross burn rate is the total amount of operating costs a business has, while net burn rate takes into account revenue and profits.

Gross burn rate is the total amount of money a business spends on operating costs, such as rent, utilities, salaries, and supplies. For example, if a startup spends $5,000 per month on rent, $2,000 on utilities, and $10,000 on salaries, its gross burn rate would be $17,000 per month. Gross burn rate is important to understand because it gives a business an idea of its total expenses and how much money it needs to bring in to cover those costs.

Net burn rate, on the other hand, takes into account a business's revenue and profits. It is calculated by subtracting a company's revenue from its gross burn rate. For example, if a startup has a gross burn rate of $17,000 per month and revenue of $20,000 per month, its net burn rate would be $3,000 per month. Net burn rate is important because it gives a business an idea of how much money it is losing or gaining each month, and can help it make strategic financial decisions.

Understanding the difference between gross burn rate and net burn rate is important for businesses, as it can affect their calculation of cash runway. By understanding both types of burn rate, a business can make informed decisions about its financial health and plan for the future.

Read the full blog on Finanshels

Are you ready to handle a recession or are you still worried about your finances Book a Free Demo and see what Finanshels can do for you.