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Approaching Uncertainty

Revisiting your business’s cash burn rate and runway in a slowing economy

Posted by sayam

July 8, 2022

According to JPMorgan Chase & Co, as of June 15, there was an 85% chance of an economic recession based on stock market price activity. The investment banking firm cited “heightened concerns about the prospect of a US recession which could become self-fulfilling if they persist," in a related memo.

Meanwhile, Federal Reserve Chairman Jerome Powell told the Senate Banking Committee on June 22 that a recession was unlikely, but consumers and investors are not convinced. With inflation at a four-decade high and the Fed’s recent 0.75 percentage point interest rate, talks of a looming recession are only getting louder.

While some industries are more affected than others by continued stock market volatility and the inflationary environment, no business or sector is 100% safe in an economic downturn. So what should business owners do?

The best way to prepare for an economic downturn is to reduce your business’s cash burn rate and extend its cash runway. We’re going to show you how you determine these figures amid a potentially changing scenario so you aren’t left unprepared if the market continues to shift.

What is burn rate?

Burn rate is the actual amount of cash your account has dropped in a month. It is typically used to measure how fast a company spends (burns) its cash reserves or funds before it starts generating a positive cash flow. Calculating your burn rate can help you estimate when you will need more funds or run out of cash.

For example, if you start your business with $50,000 in cash and your operating expenses are $10,000 a month, you should start generating revenue or raise more funds by the fifth month.

If you have up-to-date financial records, you can simply use the operating income and expenses from the cash flow analysis to determine your burn rate.

On another note, investors will be keenly interested in your burn rate so they have an idea of how much time is left before your company's cash runs out — assuming there is no change in its burn rate. It also helps them understand how much capital your company needs to develop its product and when it should start earning a profit.

How to calculate burn rate

It’s important to distinguish between gross burn rate, which measures your monthly operating expenses without taking revenue into account, and net burn rate, which shows cash lost in a single month.

Gross burn rate = Cash balance previous month – cash balance current month

Gross burn rate example: You currently have $50,000 in cash on hand and last month had $65,000 in cash holdings.

Gross burn rate = $65,000 - $50,000 = $15,500

Net burn rate = (revenue - operating expenses*) / starting capital** x 100

*Operating expenses refers to everything spent to keep the business running, like rent, utilities and wages.

**Starting capital refers to the amount of cash initially invested in the business.

Net burn rate example: You launched your business with a $1 million investment, and in one month it had $24,400 in revenue and $170,000 in operating expenses.

Net burn rate = (24,400 – 170,000) / 1,000,000 = 14.56% for that particular month.

What is a cash runway?

Cash runway is the total time a company can continue its general daily operations before exhausting cash on hand.

Companies typically spend between 18 and 21 months moving from one funding round to another, research shows, suggesting a cash runway of 18 to 21 months is sufficient for a business to operate between funding rounds.

However, it may be more difficult to raise funds or obtain a loan during an economic downturn. Determining your runway helps keep you from being caught off-guard.

Talk to us about how our outsourced business services can help your startup increase cash flow and efficiency.

How to calculate cash runway

Assuming your books are up to date, accessing the financial data you need to periodically calculate your cash burn rate and runway is pretty straightforward.

Cash runway = total cash held / burn rate = # months before running out of money

For example, if you have $1,000,000 in your bank account (cash balance) and monthly operating expenses of $125,000 (burn rate), you’d be able to continue operating as normal for eight months without raising any additional cash.

In general, business owners should confirm their firm can remain viable over the next 24 months without requiring additional cash.

Forecasting your revised runway

Amid current market uncertainty, consider mapping out your runway for varying scenarios, such if the market continues its downward trend. Keep in mind that before forecasting revenue goals, you need a long enough runway to accommodate unexpected costs.

To demonstrate how burn rate and cash runway are affected by different levels of declining revenue, below is an example for a hypothetical business with $100,000 cash on hand and $10,000 in monthly operational costs.

	Revenue/month	Burn rate	Cash runway
revenue now	$6000	$4000	25 months
10% drop	$5400	$4600	21 months
15% drop	$5000	$5000	20 months
20% drop	$4800	$5200	19 months
25% drop	$4500	$5500	18 months

Strategies to extend your cash runway

Knowing your cash runway helps you estimate how long your business can withstand an economic downturn. To increase the length of your runway, consider the following:

1. Raising funds before you run out of cash.

2. Paying off higher-interest debts by refinancing them with longer-term or lower-interest loans. If a recession happens, lenders will be less willing to refinance.

3. Expanding your business into a different market segment or geographic region.

4. Outsourcing back-office tasks for greater flexibility in changing circumstances.

5. Assuming operating expenses will grow but revenue won’t when calculating your runway.

Want more?

Since 2006, Escalon has enabled thousands of startups to have a proactive approach to managing finances with our back-office solutions for accounting, HR, payroll, insurance and recruiting — and we can help yours too. Talk to an expert today.

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sayam

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Approaching Uncertainty

Revisiting your business’s cash burn rate and runway in a slowing economy

What is burn rate?

How to calculate burn rate

Gross burn rate = Cash balance previous month – cash balance current month

Net burn rate = (revenue - operating expenses*) / starting capital** x 100

What is a cash runway?

How to calculate cash runway

Cash runway = total cash held / burn rate = # months before running out of money

Forecasting your revised runway

Strategies to extend your cash runway

Want more?

Authors

sayam

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