Start-up Runway: Why Burn Rate and Cash Runway are important for start-ups
As the founder of a start-up, one faces new challenges daily. Processes are implemented step by step, structures are continuously adjusted, and the business model must first prove itself. Will the idea withstand the competition? Is there sufficient demand for the product or service? And most importantly: How long will the liquidity reserves last? This last point is particularly crucial, as a lack of funds is one of the most common reasons start-ups fail. Therefore, it is essential for start-ups to keep an eye on their finances from the very beginning and to know how long their cash reserves will last. The Burn Rate and Cash Runway are key metrics that every start-up should be familiar with. We explain how to calculate both metrics and provide tips on how to optimise the Runway Length.
Start-up Runway: A Definition
A start-up runway, also known as cash runway or in German, "Kapitalverbrauchsperiode," is a financial metric that indicates how long a start-up can survive with its existing cash reserves before new capital is required.
This period, often measured in months, is determined by the current expenses and, if applicable, the company's income. The runway helps founders and investors understand how much time a start-up has to achieve important milestones or secure the next round of financing before the money runs out.
The term "runway" can be translated as "start and landing strip." A longer runway (runway length) gives a start-up more time to grow, develop products, and establish itself in the market before new capital needs to be raised. It is an essential metric that plays a central role in a start-up’s financial planning and strategic decisions.
What is the Burn Rate?
The goal of every start-up is to develop a sustainable, profitable business model and quickly achieve positive cash flow. However, this can take years. In the early stages, start-ups often report negative cash flows due to high costs and low revenues. Therefore, it is important to have sufficient financial resources to cover initial expenses and investments.
The Burn Rate is a central liquidity metric for start-ups. It shows how long the company can manage with its financial resources while maintaining a consistent cash flow without additional liquidity inflows. The Burn Rate, also known as the Cash Burn Rate, is usually given as a monthly or annual expenditure. It is a momentary figure that can change due to fluctuations in cash flow and equity increases.
When companies burn through their cash too quickly, in other words, have a high burn rate, they risk running out of money and not surviving. Conversely, a low burn rate can mean that a start-up is not investing enough money in its plans to establish itself as a successful company in the long term.
Gross Burn Rate and Net Burn Rate – What's the Difference?
When it comes to Burn Rate, a distinction is made between Gross Burn Rate and Net Burn Rate:
- Gross Burn Rate: The Gross Burn Rate is the total amount of cash a company spends each month. It includes salaries, rent, and fixed costs.
- Net Burn Rate: The Net Burn Rate is the amount a company loses each month, which is the difference between income and expenses. The Net Burn Rate also includes cash inflows typical for start-ups, such as investment funds, and shows how much money the company has taken in and spent during the month.
Calculating the Gross Burn Rate
- Gross Burn Rate = (Opening Cash Balance – Closing Cash Balance) / 12 Months = Monthly Gross Burn Rate
For example: If a start-up has £100,000 in its bank account at the beginning of the year and £30,000 left at the end of the year, this results in a gross burn rate of £5,833 per month:
- (100,000 – 30,000) / 12 Months = £5,833 Monthly Gross Burn Rate
Calculating the Net Burn Rate
(Gross Burn Rate – Cash Inflows) = Net Burn Rate
If a company, XY, has £270,000 at the start of the year, receives £60,000 in cash during the year, and has £30,000 left in its account at the end of the year, the company has a Net Burn Rate of £15,000 per month.
Formula:
- (£270,000 – £30,000) / 12 Months = £20,000 Monthly Gross Burn Rate
- £60,000 in Cash Inflows / 12 Months = £5,000 Cash Inflows per month
- £20,000 Gross Burn Rate – £5,000 Cash Inflows = £15,000 Monthly Net Burn Rate
Calculating Cash Runway – Here's How
A company's runway indicates how many months or years it can survive with consistent expenses and income. There are two main types of runway: Runway Gross and Runway Net.
- Runway Gross refers to the Gross Burn Rate and considers only expenses in the calculation.
- Runway Net, on the other hand, refers to the Net Burn Rate and considers both the company's expenses and its income.
Runway Gross
Formula:
- (Original Cash Balance / Gross Burn Rate) = Runway Gross in Months
For example, if company XY has £270,000 in its account at the start of the year and has a Gross Burn Rate of £20,000, this results in a Gross Runway of 13.5 months:
- £270,000 / £20,000 = 13.5 Months Runway Gross
Runway Net
Formula:
- (Original Cash Balance / Net Burn Rate) = Runway Net in Months
If company XY has £270,000 in its account at the start of the year and has a Net Burn Rate of £15,000, this results in a Net Runway of 18 months:
- £270,000 / £15,000 = 18 Months Runway Net
How Long Should a Start-up’s Runway Be?
Start-ups should aim for a runway of approximately 18 to 21 months. This allows for 12 to 15 months to achieve milestones and an additional three to six months to secure new financing. However, the ideal length depends on the business model, growth strategy, and many other factors. According to Startup Genome, 65% of start-ups have a runway of six months or less, and 41% even have less than three months.
To extend the runway, start-ups should apply strategies such as increasing revenue, reducing costs, and using non-dilutive financing options.
Extending Start-up Runway: 3 Effective Strategies
Extending a start-up's runway is crucial for allowing enough time to develop the business model and achieve important milestones. Here are three proven strategies to lengthen the cash runway and secure the financial stability of a start-up.
1. Try Strategies for Increasing Revenue
There are creative ways to increase revenue without significantly raising costs, thus extending the runway:
- Upselling and cross-selling to existing customers
- Implementing new pricing strategies
- Reaching out to additional customer groups
2. Control and Reduce Costs
Start-ups should aim to reduce unnecessary expenses as much as possible. Since rent and salaries are two of the biggest cost drivers in start-ups, alternatives such as renting co-working spaces or temporarily using freelancers instead of full-time employees should be considered.
3. Non-Dilutive Sources of Financing
To increase liquidity without diluting the company structure, start-ups should consider non-dilutive financing sources. A prominent example is venture debt. This is debt capital provided in the form of loans from external lenders or banks. The advantage of venture debt is that it increases liquidity without giving up equity in the company. However, this form of financing is typically reserved for start-ups that have already successfully proven their business model and have a stable revenue base.
Keep Your Burn Rate and Cash Runway Clearly in Sight – with Tidely
It is a well-known fact that financial bottlenecks are one of the main reasons start-ups fail (CB Insights). Therefore, it is crucial that you always have a clear overview of your financial resources: How quickly are you burning through capital, and how long is your cash runway if you maintain your current income and expenses?
Knowing your start-up runway and burn rate enables you to build strategic plans for your company's future and keep your cash management under control.
Tidely provides exactly this overview. Our user-friendly dashboard not only shows your burn rate and cash runway but also many other essential financial metrics. With Tidely, you can keep a firm grip on your liquidity. Additionally, our platform allows you to create cash flow forecasts and explore and analyse various financial scenarios. The insights gained support you not only in internal decision-making processes but can also be effectively used in communication with investors through Excel exports.
