Burn rate and cash runway – an introduction
Burn rate is the amount of money a company spends each month. Cash runway is the amount of time it has left before it runs out of money. It's an important metric that any funded or loss-making business and investors track to establish how long before they need to raise investment.
What is burn rate?
Burn rate is the rate at which a company spends its available capital over a specific period, usually measured monthly. It's a crucial metric for start-ups and businesses to monitor their financial health and sustainability.
Burn rate is the rate at which a company is spending its cash reserves. It’s typically expressed in months e.g., "the company's burn rate is currently £150,000 per month." In this sense, the word "burn" is a synonymous term for negative cashflow.
Cash runway is the number of months left before the company will run out of cash, or hit zero cash date.
Why is burn rate important?
The burn rate measures how fast a company is spending its available cash. If a business burns cash too fast, it risks running out of money and failing. If a company doesn't burn enough cash, it might not be investing in its future and could fall behind its competition.
Typically, early-stage companies, particularly SaaS businesses, will go through several investment rounds before their product is sufficiently mature and their customer base large enough that they are generating cash.
Understanding cash runway is important to allow the management team sufficient time to plan the next fundraise well in advance and control the narrative, rather than a chaotic scramble when cash reserves are running out leaving the company vulnerable to a lower valuation.
What does net cash burn and cash runway look like?
How do you calculate burn rate and cash runway?
The formulae to calculate burn rate and cash runway are:
Burn rate = Average monthly reduction in cash
Cash runway = Cash / Burn rate
Burn rate and cash runway worked example
If a company has £1 million in the bank, and it spends £110,000, £100,000 and £90,000 across the last three months, its burn rate would be £100,000, and its runway would be 10 months, calculated like this:
Burn rate = (£110,000 + £100,000 + £90,000) / 3 months = £100,000 per month
Cash runway = £1m / £100,000 = 10 months
Note: Burn rate can either be calculated on an average basis i.e. over three months as above, current month or using a forecast burn rate. Choosing which method to calculate burn rate depends on how fast the business costs are fluctuating and what is a better predictor for the future.
Conclusion
Understanding burn rate and cash runway is fundamental to any fast-growth tech business. Management teams should be measuring and monitoring both of these to better understand cashflow and the timeline until cash runs out. This helps plan spend and the timeline for future fundraises, or cut costs to become cashflow positive.
