How To Calculate Your Business Runway

A business runway is the amount of time a business can operate before running out of cash. Having a strong runway helps companies allocate resources when they experience financial hardships or a recession. It can also tell you if your business is overspending.

When a business runs out of cash, it is a nightmare for any business owner, so calculating your business's runway can tell you where your business stands in its sustainability. A good standard is to have a runway of at least one year.

Calculating Your Business Runway

To calculate your business's runway, you'll need to know how much cash your company has available (what's in their account), and the average burn rate.

Burn Rate

The burn rate is the rate at which a company loses money. Whether your business is doing well or not, it's an essential metric for you to calculate.

The formula for calculating the burn rate is quite simple:

(Last month's balance - This month's balance)/Months (Starting balance - Ending balance)/Months

Subtract the end balance from the starting balance of the business within a particular period. Then, divide this difference by the number of months within the specified period. The result is the burn rate.

Example

A business started the year with $4,000,000 in cash and ended the first quarter with $1,000,000.

Burn rate = ($4,000,000 - $1,000,000)/3 = $3,000,000/3 = $1,000,000

t'This means that this business spends an average of $1,000,000 every month.

Runway Formula

Now that you can calculate the burn rate, you can go ahead and figure out your business's runway. The formula for the runway is:

Runway = Available cash/Average burn rate

Example

Let's assume that a business's current balance is $200,000, and last month's cash balance was $250,000.

Burn Rate = $250,000-$200,000 = $50,000

Therefore, Runway = $200,000/$50,000 = 4 months

From the calculation above, this start-up has only four months of cash before running out of money.

Extending Cash Runway

Having a decent runway means that there is enough revenue to help a business survive during a crisis. To extend cash runway, companies can find ways to reduce their burn rate--expenditures--and increase their revenue and funding.

Monitor Cash Flow Keenly

When businesses have a healthy cash flow, it will help them thrive. This is why business owners should consistently look for ways to improve their business cash flow.

Cash flow refers to the total amount of money coming in and out of a company's bank account. When you know your cash flow, you'll see how your cash reserves grow and shrink within a particular period. You can calculate business cash flow using the following formula:

Cash flow = Income - Expenditure

If it decreases from month to month, it means that the business needs to increase its sales and revenue.

Reduce Expenditures

Business owners should always look into their expenditures every month to identify areas where they can reduce expenses to build a cash runway. Conducting regular cost reviews will also go a long way.

Don't Handle Receivables With Levity

Receivables refer to business invoices for which you haven't received payment. If you handle business receivables properly, it will help you build the cash runway of your business. The time frame you give to customers to pay these invoices directly impacts a fiscal period's cash burn. Consider these tips to accelerate your invoice payment process:

• Avoid delay in sending invoices to clients
• Set up easy and fast payment systems for clients (electronic auto payments)
• Ensure that you send accurate and precise invoices
• Give them a short grace period
• Send reminders a few days before payments are due
• Always thank clients after making their payments

Final Verdict

By figuring out your business's runway, you'll know exactly where you stand and be able to make more informed financial decisions. If you see that it's too low, do what you can to increase income and reduce expenses.