The Importance of Burn Rate and Cash Runway
Cash is essential for any business, regardless of the economic climate. It enables operations, employee payments, and keeps the doors open. Without cash, there is no business.
In times of crisis and uncertainty, understanding your cash position becomes even more crucial. If you run a startup or small business during such times, you must consider alternative plans. Currently, about 20% of the United States is under lockdown, and only "essential" businesses are operational. This raises concerns for every business owner.
To address these concerns and provide an action plan, you need to review and revise your financials. A good starting point is understanding and calculating your cash burn rate and cash runway.
How to calculate the burn rate?
The burn rate is calculated by subtracting monthly cash spending from monthly cash intake.
To determine this, begin with your monthly expenses. These include fixed costs like rent and utilities and variable costs such as salaries, travel, supplies, and services. The sum of these expenses is your Gross Burn Rate.
Gross burn rate = (Total variable expenses + Total fixed expenses)
Next, consider your monthly cash inflow. This differs from the amount you invoice since not all invoices are immediately paid. Only consider the cash you’ve received.
Subtract your Gross Burn Rate from your cash received. This is your Net Burn Rate (also referred to as Burn Rate). If you’re bringing in more cash than you’re spending, congratulations on having positive cash flow. If the number is negative, it indicates negative cash flow, and it represents the amount of cash burned each month.
Burn Rate = Cash Received – Cash Paid Out
Alternatively, you can calculate your burn rate by comparing your cash balance at the beginning and end of the month using your accounting system or bank account. The difference between these two values is your cash burn rate.
How to calculate cash runway?
Cash runway is the amount of time your cash will last while you’re burning cash.
To calculate the cash runway, assess your bank account and determine your available cash. Divide this number by your burn rate to estimate how long your business can survive without changes.
Cash Runway = Cash Balance รท Burn Rate
Typically, it is common to secure funding and utilize that cash to build your business. During this phase, expenditure exceeds revenue. The goal is to reduce your burn rate to zero and achieve positive cash flow before your funds run out.
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