What Is Cash Runway? Definition, Significance, & Calculation

What Is Cash Runway? Definition, Significance, & Calculation

Most businesses deal with some level of unpredictability with both their expenses, revenue, and profitability. This is even truer for early-stage startups. To deal with the unpredictable nature of cash flows, it’s important for business owners to know what their company spending and cash balances are at any given time. This will allow you to better manage your budgets and plan for the days ahead.

Documenting cash inflows and outflows includes analyzing your cash runway. As mentioned, cash runway is an important metric for startups that are not yet bringing in a profit—meaning they are still not making as much in revenue as they are spending.

In this article, we'll dive into what cash runway encompasses, why it's the cornerstone of financial planning, and the precise steps to calculate and manage runway. Additionally, we'll explore some helpful strategies to lengthen your cash runway and outline the benefits that come with an extended buffer.

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What Is Cash Runway?

Simply put, cash runway represents the amount of cash you have on hand and how long it will last if your expenses exceed your revenue and you don’t predict any new funding coming. In other words, it shows the amount of money you have on hand to spend the way you’re spending before you exhaust your cash reserves.

In order to calculate your cash runway, you first need to figure out your cash burn rate. Specifically, your net burn rate, which is one of two types of cash burn. Before you can figure out your net burn, you need to find your gross burn rate, or how much you spend each month on operating expenses, and then subtract what you make in revenue.

For example, if a company spends $10,000 a month on office space, $20,000 on equipment, and another $20,000 on salaries and wages, then its gross burn rate would be $50,000. If it’s producing revenue, its net burn rate would be different, and would adjust the total amount of monthly spend.

Say the company generates $30,000 in revenue monthly, with the cost to make its product at $15,000 monthly (the company’s cost of goods (COGs)), then the net burn would equal $35,000 a month.

$30,000 (revenue) - $15,000 (COGS) - $50,000 (gross burn) = $35,000 (net burn)

After you’ve calculated your net burn, you can calculate your cash runway by dividing your cash balance by the amount you spend each month. This will give you a rough idea of how long you can operate without making any changes to cash flow.

Let’s use the example from above to illustrate this calculation. If the company has a cash balance of $1,000,000 and a monthly burn rate of $35,000, it would have roughly 28 1/2 months to operate at its current net burn without any additional fundraising.

Why Is It Important?

If you know what your company’s cash runway is, you can:

  • Know exactly how much money you have in the bank and what your burn rate is
  • Ensure your company is running efficiently
  • Strategize when you need to fundraise
  • Identify if you are overspending and avoid tapping into reserves
  • Determine if there is excess capital to put towards your cash reserves

Having a proper understanding of your cash runway is significant in ensuring your company is running efficiently, avoiding overspending, and planning fundraising needs accordingly. The fundraising process can be tedious and lengthy, so it is important to know when to allocate resources for securing the next fundraising round.

At the end of the day, cash runway can help you answer the question that drives the business concept of default dead or alive: “Will the company turn cash flow positive before its runway ends?”

Being default alive means you are on track to becoming profitable with the resources currently on hand, while being default dead means you don’t have enough on hand to cover your expenses.

Knowing your cash runway can help prevent you from defaulting dead, and avoid failing due to poor financial planning.

What Is a "Good" Cash Runway?

As we often say, it’s impossible to generalize what a “good” cash runway is, since it will depend on what stage of growth a business is in. It’s tempting to think that keeping expenses low and cash runway long is the goal, but it actually might indicate that a company is not taking some of the risks necessary to start a business.

We are not telling you to start spending like crazy, but rather not to be afraid of spending money now that will pay off later. Having advisors and fellow entrepreneurs that you trust is essential, because they can give you some input on whether you’re roughly on track.

How to Calculate Cash Runway Using the Burn Rate

In order to calculate your cash runway, you need to know your burn rate. Burn rate, or gross burn rate in this case, is the estimated monthly cost to run your business, and includes all expenses necessary for your business to operate. It is important to overestimate your burn rather than underestimate it.

It should also be noted that gross burn rate is sometimes confused with another term, net burn rate, which simply represents your monthly net loss. If you’re not generating any income, the distinction between these two terms is less important.

However, if you are bringing in monthly income, then the distinction does indeed matter. In this article, when we mention burn rate, we’re always referring to gross burn rate.

When calculating your burn rate, include projected future expenses if possible. You can calculate your historical burn rate from previous months’ bank statements by looking at the cash outflows. Here is a breakdown of the basic formula for calculating burn rate:

Burn Rate = (starting cash balance – ending cash balance) / # of months

After you’ve calculated your burn rate, you can determine your runway by dividing your current cash balance by your estimated burn rate. The cash runway formula looks like this:

Cash runway = current cash balance / burn rate

After calculating burn rate and runway, you will have a better idea of how long you have to operate at your current burn rate.

Strategies to Extend Your Runway

It is impossible for anyone to predict how the market will evolve from one state to the next. However, that doesn’t mean you shouldn’t prepare for a rainy day.

Regardless of your cash balance, allocating your capital efficiently and being prepared for changing economic circumstances can be vital for your company’s ability to operate. Maximizing your runway is not just about preserving cash. Developing a strategy for extending your cash runway while adding value is essential for generating long term growth.

There are several strategic approaches to extending your cash runway that can prevent insolvency, as well as contribute to creating additional value.

Generate Additional Revenue

Although it is harder said than done, generating additional revenue to fund operations is a great way to extend your cash runway. Shifting focus on securing income generating ventures such as partnerships and contract revenue for biotech companies is a good strategy to extend your runway, while creating additional value to your company.

Tighten Up Receivables & Collections Processes

Having more accurate financials allows you to evaluate your current progress and make more suitable decisions about future spending. Improved financial processes can be achieved by closely monitoring cash inflows and cash outflows. Accurate tracking ensures nothing goes unnoticed, making it easier to address issues early on before they become unavoidable.

Redirect Focus on Cutting Expenses

Cutting expenses is the most traditional way of extending cash runway. Finding methods to reduce your operating expenses can seem difficult, but is achievable by continuously managing your cash and creating a priority list for expenses. Certain expenses are required for your business to operate sufficiently, and should be placed at the top of your priority list. Start cutting costs by reducing spend on expenditures on the bottom of your priority list.

Be Prepared for Your Next Round of Funding

Investors are becoming more conservative and holding onto more cash as the current market downturn continues. As a result, raising funding through venture capital (VCs) will be more competitive.

This is why it is important to be fully prepared for raising additional funding. In the event that something doesn’t go according to plan—your funding round closes a couple of months later than anticipated, for example—having an existing strategy for extending your runway will come in handy.

Demonstrating financial maturity and an understanding of your cash runway will show investors you will know how to manage a large cash injection should they choose to invest in your business. If you’ve already received funding, buckle down on accomplishing investor milestones along with prioritizing R&D to ensure a better possibility of securing the next funding round.

Explore Alternative Funding Sources

Non-traditional forms of funding can make a significant difference in extending your cash runway. However, it is vital that you find alternative financing partners interested in the growth of your company. Financing partners with founder friendly terms can be pivotal in extending your runway.

For example, Excedr’s lab equipment leases provide biotechs and biopharmas with a way to extend their cash runway while acquiring the equipment needed to perform R&D and hit important investor milestones.

Because we don’t ask for any equity or impose burdensome terms (like collateral, IP pledges, or debt covenants) in our leases, we put the founders first, allowing them to support their business and its growth without giving up a piece of the pie or enter into a less-than-ideal contract.

Prioritize Extending Your Cash Runway

An extended runway ensures a greater possibility of your company being able to survive possible obstacles that result from economic slowdown such as unsure future funding and decreased overall spending in the economy. In the event that the extended cash runway is not needed in the future, all of the capital can be reallocated back into R&D or other growth generating operations. Planning and strategizing for the future will not hinder your success, it will simply make the inevitable hurdles less challenging.

In the current economic climate, it is very important to strategize how you will go further with the current capital you have. Failing to plan is planning to fail. Start by understanding the cash runway and calculating how many months you have at your current burn rate.

Ultimately, finding ways to improve cash utilization by creating additional revenue, exploring alternative funding sources, and finding other methods to plan for contingencies, can be a deciding factor for long term success.

Excedr’s lab equipment leasing program is just one realistic option for extending cash runway, and offers founder-friendly terms that can help you hold onto more capital and equity while getting the lab equipment you need to power your R&D.