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Running out of money is the second most common reason businesses fail, so you need to know how to calculate an adequate cash runway to avoid default.

In this article, I will teach you what I mean by the cash runway and my tips on ensuring a healthy cash position.

Are you burning too much cash?

As COVID-19 increases uncertainty in almost every part of your business, it’s never been more important to reduce your cash burn and extend your runway to between 12 and 24 months. Anything under 9 months is concerning.

As you consider your path to sustainable cash flow, keep these four guiding principles in mind:

Minimize the impact to your employees.

They’re on the front lines serving your customers each day. You want them to be able to focus on providing the best product, service and support possible.

Revisit your strategy now.

The playing field from a selling perspective has never been more even on an international level – all salespeople, regardless of geographical location are selling over video. This is a major game-changer!

Limit the risk to your business.

As uncertainty mounts around international supply chains, exchange rates and cash collections, exercise control on what you can directly control.

Set yourself up to kickstart growth after the downturn passes.

You don’t want cuts to be so draconian that you’re at a disadvantage when normal market dynamics return. And it will return. When making cost cutting decisions today, you need to also have one eye on the future as well.

Let's take a closer look at what I mean by the cash runway.

What is your cash runway?

Calculating the ideal runway length is crucial to ensure all planes are able to take off and land safely.

If the runway is too short, it won’t be safe for planes to take off or land.

If the runway is too long, you wasted resources without providing additional benefits.

In the business world, you will often hear entrepreneurs or CEO’s talk about a Cash flow runway.

This refers to how many months your company can operate before it runs out of cash.

It is crucial for CEO’s to remain aware of their cash flow runway, and being able to calculate runway accurately is critical for survival.

How to calculate your gross cash burn rate?

Gross burn rate refers to the total amount of cash you’ve spent each month.

If you begin the year with $180,000 in your bank account and at the end of the year, with no new cash, you have a remaining balance of $60,000, then you have a gross burn rate of $10,000 per month.

(Original Cash Balance — Remaining Cash Balance)/12 months = Gross Burn Rate

$180,000 original cash balance — $60,000 remaining cash balance = $120,000

$120,000/12 months = $10,000 monthly burn

How do you calculate the net burn rate?

Net Burn Rate is the difference between cash in and cash out. If you begin the year with $180,000 in your bank account and at the end of the year, with $30,000 cash influx, you have a remaining cash balance of $60,000, your net burn rate would be $7,500 per month.

$180,000 original cash balance — $60,000 remaining cash balance = $120,000

$120,000/12 months = $10,000 monthly burn

$30,000 cash influx/12 months = $2,500 added cash per month

Gross Burn Rate — Added Cash = Net Monthly Burn

$10,000 gross burn rate — $2,500 added cash = $7,500 net monthly burn

How do you calculate your cash runway?

You can calculate your cash flow runway by taking your beginning cash balance and dividing that value by your net burn rate.

In this case, a $180,000 cash balance divided by $7,500 net burn equates to 24 months of runway.

Cash Balance/Net Burn Rate = Months of Runway

$180,000/$7,500 = 24 months of runway

The second most common reason why businesses fail is running out of cash. Therefore, you should aim to keep your burn rate as low as possible.

If you have a negative burn rate, this is ideal because it means you are building cash reserves instead of using them up.

Running out of money is the second most common reason businesses fail, so if you need any assistance with cash flow, please lock in a time in my calendar to chat about how I can help you.

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