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Finance guide: Cash runway (calculation, uses, examples)
Learn more about cash runway and what it means for your business
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1 minute
October 7, 2024
Whether you’re at the beginning stage of fundraising for your early-stage startup or running a successful SMB, cash runway is a valuable metric to track so that you can take strategic action to secure your company’s success and excel.
The cash runway will signal what kind of actions you will need to take to improve your company’s financial health.
Let’s review the cash runway and details of this key benchmark.
Key takeaways
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Cash runway refers to the time a company can continue operating based on its current cash balance and burn rate.
It is a critical metric for startups and early-stage companies that are not yet profitable because it indicates how long the company can continue operating before raising additional funding or becoming profitable.
Monitoring cash runway is important to ensure a company does not run out of money unexpectedly.
By monitoring this measure, startup founders can make necessary adjustments, such as reducing expenses or seeking new funding, before the company reaches the end of its runway.
Cash on hand refers to the physical cash, bank account balances, and other highly liquid assets that a business has readily available to cover immediate expenses and operations.
This includes currency, coins, and money in checking/savings accounts that can be easily accessed and used for business purposes.
Note that the company’s cash on hand does not include funds that the business cannot easily spend or access, such as the minimum deposit required to keep a bank account open or assets that can be sold.
Burn rate refers to the rate at which a company is spending its cash, typically expressed on a monthly basis. There are two types of burn rate.
Gross burn rate is the total amount of money spent on expenses like salaries, rent, marketing, etc. Net burn rate is the amount of cash spent after accounting for cash inflows.
Much like cash runway, the burn rate is an important metric for startups and early-stage companies that are not yet profitable.
Burn rate indicates how quickly they are using their available cash. Cash runway refers to the amount of time a company can continue operating based on its current cash balance and burn rate.
Positive cash runway indicates the company has enough cash on hand to continue operating for a certain period of time, based on its current burn rate. Use the following formula as a template to track your cash runway:
Cash on Hand / Burn Rate = Months of Runway
A positive cash runway gives the company more time to become profitable, raise additional funding, or make necessary adjustments before running out of money.
An optimal cash runway is generally around 12 to 18 months.
A negative cash runway indicates the company is spending more cash than it is bringing in each month, resulting in a negative cash flow.
With a negative cash runway, the company is "burning" through its cash reserves. This is a dangerous situation for startups and early-stage companies that are not yet profitable because, if the situation does not improve, the company is projected to run out of money.
Business owners must pay attention to a negative cash runway and take immediate action, such as cutting costs, increasing revenue, or raising additional funding, to extend the company's runway and avoid being short of funds.
In some cases, founders and employees may need to use their personal cash reserves to supplement the company's runway. These are types of runway cash flow:
Cash runway is calculated by dividing a company's current cash balance by its monthly burn rate. Remember, the burn rate is the amount of cash the company is spending in excess of what it is bringing in each month.
Cash Balance / Monthly Burn Rate = Cash Runway
For example, if a company has $200,000 in cash and a monthly burn rate of $15,000, its cash runway would be 13 months ($200,000 / $15,000 = 13 months).
Interpreting cash runway is important because it provides valuable insights into a company's financial health, informs strategic decision-making, helps attract investors and venture capital groups, enables proactive planning, and is applicable across different business stages.
Keeping an appropriate level of cash on hand, typically 12 to 18 months' worth of operating expenditures, is imperative for businesses to have funds available to cover costs during slow periods or unexpected events.
Having sufficient cash on hand allows businesses to take advantage of investment opportunities that could help grow the business and pay for immediate expenses without waiting for financing or incurring debt.
The amount of cash a business has indicates its financial health and can influence how potential investors and partners view the company.
While there’s no universal threshold for cash runway, one of around 12 months is generally considered optimal for startups and early-stage companies.
A cash runway that shrinks over time (indicating the company is spending more than it is bringing in) is a concerning sign that the runway may be getting too short.
This is when startups and early-stage companies are advised to proactively manage their cash runway and take action before it gets dangerously low. Companies can cut costs, increase revenue, or raise additional funds.
Similarly, a negative cash runway, where the company is spending more cash than it has, is a high-risk scenario that requires immediate action to avoid running out of money.
The term “default dead” sounds alarming, and it is. A startup is considered "default dead" if it does not have sufficient cash to survive and maintain a healthy growth rate until it becomes profitable.
Default dead startups are burning through their cash without showing signs of recovery with their current resources.
Default dead companies will need to raise additional investment to sustain operations because they are not on track to become profitable before running out of money. Startups in this situation have less leverage in fundraising.
Why? Because they are dependent on investors to keep the business running. That’s why founders of default-dead startups may have to accept worse terms from investors.
This term is more reassuring. A startup is "default alive" if it is on a path or predicted to reach profitability based on its current expenses, growth, and resources without needing new investment.
Default-alive startups do not necessarily need to raise more funding to survive. Because they are in a good financial position, they can be more selective and negotiate better terms with investors.
Maintaining a default alive status is especially important during economic downturns when fundraising may be more challenging.
Founders of default-alive startups can focus on evolving the product and growth rather than solely on raising more money to stay afloat.
Let’s review the steps to determine the cash runway.
Let's say the startup has a current cash balance of $500,000 and a monthly burn rate (net cash outflows) of $25,000
To calculate the startup's cash runway:
Based on the current cash balance of $500,000 and a monthly burn rate of $25,000, this startup has approximately 20 months of cash runway before running out of money, assuming the burn rate does not change.
A Saas company is a software provider that delivers its applications to customers over the internet through a subscription-based model rather than selling packaged software. Let’s review a SaaS cash runway example.
Let's say the SaaS startup has:
- Current cash balance: $1,000,000
- Average monthly gross burn rate (total expenses): $45,000
- Average monthly revenue: $12,000
To calculate the startup's cash runway:
Net Burn Rate = Gross Burn Rate - Average Monthly Revenue
Divide the current cash balance by the average monthly net burn rate:
Based on the current cash balance of $1,000,000 and an average monthly net burn rate of $33,000 (gross burn of $45,000 minus $12,000 in average monthly revenue), this SaaS startup has approximately 30 months of cash runway before running out of money, assuming there will be no changes to the burn rate or revenue.
As the founder, you will have to make difficult decisions. Do not be afraid to act methodically and strategically to improve your startup’s runway. Having real-time cash runway data can help startups take action. Here are some examples.
Focus on reducing the startup's burn rate, which is the net cash outflow each month. Cut costs by reducing headcount or office space, renegotiating vendor contracts, eliminating unnecessary spending, and paying off the company’s credit cards in full every month.
Revisit your business model. Is the company meeting its KPIs? Raise prices and monetize existing assets to generate more cash inflow. Acquire more customers, improve sales and marketing strategies, and create recurring revenue streams.
Pitch to investors and secure additional capital, equity, or debt financing. Also explore alternative funding sources, such as grants, loans, or revenue-based financing.
Sell excess inventory or assets that are not essential to the core business.
Reduce the time it takes to collect customer payments and make payments to vendors to improve your accounts receivable (AR) and accounts payable (AP) processes.
Successful CEOs and investors closely monitor a company's cash runway to make informed decisions about fundraising, identify areas for improvement, build investor confidence, and time major investments.
To reiterate, the cash runway metric provides valuable insights into the company's financial health and runway for growth.
Use the cash runway calculation to proactively plan for the next fundraising round, ensuring you have enough time to secure new funding before the current runway expires.
Remember, investors closely monitor a startup's cash runway. A company with a shorter cash runway has less leverage to negotiate with investors.
Cash runway is a great barometer to highlight inefficiencies. A shrinking cash runway over time can be an early warning sign that the business is spending more than bringing in, prompting the need to take corrective action.
Founders and CFOs can use this metric to identify areas where the company is overspending and make adjustments to extend the runway (such as reducing expenses or increasing revenue, as we’ve stated in the previous section).
Investors view a healthy cash runway as a sign of the company's financial stability and ability to execute its growth plans.
Founders can use the cash runway calculation to demonstrate to investors that the company has sufficient funding to reach key milestones, making it more attractive for investment.
A strong cash runway gives companies more flexibility to invest in growth opportunities, such as hiring, marketing, or product development, without the immediate pressure of running out of money.
Divide the current cash balance by the monthly burn rate to calculate the cash runway.
Cash Runway = Current Cash Balance / Monthly Net Burn Rate
Remember, the monthly net burn rate calculation is:
Monthly Net Burn Rate = Gross Burn Rate - Average Monthly Revenue
When it comes to cash runway, there is no one-size-fits-all. Generally, a 12-18 month cash runway is optimal for startups and early-stage companies.
Cash runway refers to the length of time a company can continue operating based on its current cash balance and burn rate.
Even though they are closely related metrics, cash runway and cash burn (also called the burn rate) do not measure the same thing. Let’s first review the cash burn.
The cash burn (or burn rate) refers to the rate at which a company is spending its cash, typically expressed monthly. Cash burn does not directly measure time but rather the amount of cash being spent over a given period (e.g., $40,000 per month).
Cash runway refers to the time a company can continue operating based on its current cash balance and cash burn (burn rate). It is calculated by dividing the company's current cash balance by its monthly net burn rate and expressed in months.
To recap, cash burn (also known as burn rate) measures the amount of cash being spent, but not the duration. Cash runway measures the duration (in months) a company can continue operating based on its current cash balance and burn rate.
The two metrics are closely linked, but they represent different aspects of a company's financial situation and are used for different purposes.
Tracking burn rate is used to assess expenses and make spending and cutting decisions, while measuring cash runway measures the amount of time a company can continue operating with its current expenses and income.
"Extending cash runway" refers to taking actions to increase the time a company can continue operating before running out of cash and getting to positive cash flow.
The "cash runway rate" refers to the burn rate or the rate at which a company spends its cash, which is a key input for determining its cash runway. Monitoring both the burn rate and cash runway is essential for startups to manage their finances and plan for the future.
A healthy cash position for a startup or small business is typically characterized by a 12-18 month cash runway, a controlled burn rate, efficient financial management practices, and the ability to weather unexpected challenges.
Maintaining this level of financial health is crucial for a startup's long-term success and growth.
The formula for calculating the monthly cash burn rate is:
Monthly Cash Burn = (Beginning Cash Balance - Ending Cash Balance) / Number of Months
Startups should aim to have 12-18 months of cash runway, or enough money or cash reserves to cover 12-18 months of operating expenses, to provide a healthy financial cushion and runway for growth.
This allows startups to weather challenges, take advantage of opportunities, and have more control over their financial future.
As a founder, your cash runway is your startup’s lifeline. It provides a rough timeframe of when you should begin your next fundraising round and can help you understand if you should consider reducing your burn rate.
Fortunately, you can take steps today to extend your cash runway without raising significantly more money. For example, you can invest your non-operating funds in T-Bills through Rho Treasury, earning competitive yields in U.S. government-backed securities.
Want to learn more about Rho’s business banking platform and cash management services? Sign up for a demo today.