Cash Runway is the amount of time up to which a business can operate at a loss before running out of cash. If your business is burning through $ 15,000 a month and you have $ 75,000 in the bank, you have five months before you’re in serious trouble.
Here is how to extend the cash runway of your startup. The blog speaks of ways to build the cash runway of your business.
If a business doesn’t have enough runway, they are under the risk of going out of money before they understand the market they’re looking to serve. Imagine you just develop a great product with no cash left for selling it. Trust me, this would be the worst nightmare for any entrepreneur.
For example, there is a business without any revenue. They’re spending (or burning) about $ 50,000 every month. With $ 500,000 in the bank, they have a 10-month runway.
Within these ten months, the startup would not only have to take their products to market for selling but also maintain a cash reserve that is higher than their burn.
CBInsights states that running out of runway is the second most likely reason for startups to fail.
Building a cash runway helps you allocate all the available resources when your business is going through a disruption.
How to calculate Cash Runway?
Before we discuss the methods to raise the cash runway of your business, let’s know, can you calculate it. So, here is the formula to calculate the Cash Runway of your business.
Cash Runway = Cash Balance / The Burn Rate
What is Burn Rate?
Burn rate is the rate at which a company loses money. It is usually expressed in months. For instance, if a company has a burn rate of $ 50,000 per month, it means the company is losing $ 50,000 per month. Burn rate is an important metric for companies that are operating at a loss, like startups and small businesses.
How to Calculate Burn Rate?
The formula to calculate the burn rate is quite simple, especially if you have a cash flow statement handy. Here’s the formula:
Burn Rate = (Starting Balance – Ending Balance)/Months
For a specific length of time, subtract the ending cash balance from the beginning cash balance of your business. Then, divide that number by the number of months in the selected period of time. The final answer that you get is the cash burn per month.
For example, if you started the year with $ 2,000,000 in cash and ended the first quarter with $ 500,000, your burn rate would be $ 500,000.
So, $ 500,000 would be the burn rate. It means you’re currently spending approximately $ 500,000 per month. If you keep spending at this rate, then you’ve just got about 4 months of cash left to invest in your business.
For startups and small businesses, “Cash is the King” during an economic crisis. The more dollars in the bank, the longer a company can survive as its revenue dries up.
It’s more difficult for small businesses in comparison to big enterprises to bear the stress of an economic downturn.
Startups and small-size businesses may feel the most stress when VC funding tightens or when there is a shortage of funds. As these companies fail to see an opportunity in the future during economic uncertainty, this is why these companies need a runway until they get a better idea of future growth forecasts.
There are a number of options that businesses can consider to extend their cash runway. during an economic uncertainty or when VC funding tightens. Here are 3 ways to build the cash runway of your business.
Monitor your Cash Flow Consistently!
Maintaining a healthy cash flow is essential for your business to thrive. This is why business owners and strategists are looking for ways to improve the cash flow of their business.
Did you know, a company’s cash conversion cycle is one of the most important metrics to monitor, while your business is growing? It is the total time that a dollar spent by you takes in coming back into your bank account.
Startup founders and business owners measure their profits to track the performance of their business. While calculating business profit is essential, monitoring your cash flows is important too as it allows you to understand what your cash balance looks like.
Cash flow refers to the total amount of money that’s being transferred in and out of your company’s bank account. It, therefore, lets you know how much your cash reserve grows and shrinks in a certain period of time.
Fast Pay shares a simple formula to calculate the Cash Flow of your business.
Cash Flow = Income – Expenditure
The income should include sales, investments, bank loans, grants, and other types of funding. The expenditure should take into the staff salaries, operational costs, tax and V.A.T, repayment of loans, and more.
Reduce Your Expenses!
Here is how to extend the cash runway of your startup. While you monitor your cash flow, you need to identify where you can reduce your expenses to build the cash runway of your business.
Here are a few things that you can do to cut down on your expenses.
Opt for Shared Office Spaces – Save on the operational costs of a leased office and work from co-working spaces. This will help in reducing your expenses.
Consider Outsourcing– Consider outsourcing certain tasks. So, instead of bringing in full-time resources, set up a team of offshore developers to cut down on your expenses.
Automate Most of the Tasks– You don’t need to spend time and resources to accomplish tasks manually. Automate tedious tasks such as invoicing, billing, and more to shift the entire focus towards growing your business.
Spend on What Actually Works –Be it in marketing or sales, don’t spread invest too much all in one place. Restrict your budgets to things that have proven effective before.
Create a Culture of Frugality – Spend wisely and cultivate the culture of frugality in your business. Motivate your teams to make the most out of restricted budgets.
Hold Regular Cost Reviews – Review the major expenses and try to renegotiate. Include your team in the cost reviewing process and make it a culture-building activity. These costs include operational costs, tax and VAT, repayment of loans, and similar expenses.
Take Charge of Your Receivables!
With the global economy being hit the pandemic, entrepreneurs can be seen worrying about how to raise the cash runway of their business. Taking charge of your receivables is one of the ways to build the cash runway of your business.
Receivables refer to your business’s outstanding invoices. It’s the money that your clients owe to you. The time frame you allow your customers to settle these invoices has a direct impact on the cash burn for that period.
Say, for instance, you allow invoices to be paid within an 80-days period. In this scenario, you need to be able to fund your startup’s operations for that time period without jeopardizing expenses for the coming month.
Here are a few tips that you can consider to accelerate the payment process.
- Make no delays in sending invoices to your clients.
- Make it easier for clients to make the payment by setting up auto payments electronically or via credit card.
- Make sure that the invoices sent are accurate and easy to understand as an incorrect and/or confusing invoice creates more delay in the payment.
- Send reminders five days before payments are due, and follow up immediately in a friendly tone.
- Thank your clients once they make the payment.
When your business faces economic uncertainty or shortage of funds, you should be saving more. Save up what you need and strategize on what it’s going to take to make your way to success. Take a vigilant look at what it’s going to take. Then, try hard to achieve the results.
This is where forecasting and budgeting come into the picture. They are very crucial for the survival of your business. You’ll need to create multiple sales forecasts and expense budgets to explore different scenarios. If the downturn is short-lived, what expenses you need to cut to extend your cash runway? If the downturn is going to extend, you may need to reconfigure your business and explore different business models.
To sum it all, you can build the cash runway of your business by:
- Monitoring the cash flow of your business
- Reducing your expenses
- Taking charge of your receivables
Here’s an eBook on growing your agency that also emphasizes on focusing on the finances. What do you think?