Understanding Burn Rate and Runway to Survive a Recession

 Updated: December 26, 2022

After the rocky economic climate of the last year, it’s clear to many business owners and entrepreneurs that tough timesmay be ahead – and, unfortunately, not every business will survive a recession.

With this in mind, it’s crucial to ensure your startup is prepared for the corresponding drop in business that often causes serious financial trouble for many companies. Even though its impossible to predict the future of the economy and its impact o your business, you can do a lot to prepare for a worst-case scenario.

One of the best things you can do is to keep track of high-impact financial metrics. Among the most critical numbers to know are your organization’s burn rate and runway. So let’s take a look at how these vital concepts can help you survive a recession.

Understanding Burn Rate

Burn rate is a fairly straightforward concept. For startups or other new businesses that aren’t making a profit yet, burn rate refers to how much cash is being spent over a specific time period, usually a month.

This money is being spent out of the organization’s initial capital and is used  to invest in growing your business, including:

• Hiring and paying staff
• Renting office space
• Buying equipment or supplies
• Software Subscriptions
• Etc.

The simplest way to determine your business’ monthly burn rate is to subtract your ending monthly cash balance from the cash balance at the beginning of the month. The difference is the burn rate.

Types of Burn Rates

Beyond this broad definition, it’s essential to understand that there are two distinct types of burn rates, each telling a slightly different story about the financial health of your startup.

Gross Burn Rate

This is the simplest way to calculate the burn rate. To find the gross burn rate, you’ll just need to total up all the operating costs and expenses of the period.

This is only a measure of the speed at which you are spending your cash balance, providing a straightforward look at how much cash is being spent in the business.

This is best used for early-stage startups or companies that aren’t receiving any revenue.

Net Burn Rate

Net burn rate provides a more complex view of your organization’s cash flow. To find the net burn rate, determine your gross burn rate and subtract any cash inflows or other revenue.

This gives you an accurate picture of your negative cash flow each month.

As your revenues increase or if you have access to additional funding, you can also increase spending and investment while maintaining the same net burn rate. It can also give you a sense of how close your startup is to profitability since it takes into consideration any revenue growth you may have.

Understanding Runway

Determining your burn rate is crucial to understanding our second vital concept, known as runway.

Think of an airplane runway; there’s only a certain distance the plane can travel without either taking off or crashing at the end of the pavement. The same is true with a startup runway. Runway expresses how long your organization’s cash reserves will last at current burn rates before you exhaust your funds and need to raise more money or shut down.

Like burn rate, runway is discussed in terms of whatever period of time you’d like to consider – months, weeks, or even days in some cases. Figuring out runway is also an easy financial report to calculate.

Take the total of your overall cash reserves and divide it by your net burn rate. The resulting number is the number of weeks or months your business has until it runs out of cash.

For example, let’s consider a company that begins the year with $1 million in cash. At the end of January, there’s $900,000 remaining. This would show a burn rate of $100,000 per month. Dividing this $100,000 amount by the remaining $900,000 shows that the company will have nine months of runway. What happens next will vary from business to business.

In some cases, this will just mean a new round of investment. If this is your business model, then you’ll be able to plan what is the best time to start talking to potential investors.  If sourcing venture capital is not part of your strategy, then it will give you a good timeline to make big decisions on the future of your startup.

This is why it’s so incredibly important to understand – runway provides you with a definitive date to turn things around by. Also, keep in mind that your burn rate may vary if you change any of your operating expenses.

Extending Your Runway

The easiest way to extend your runway is to reduce your burn rate. This can be done either by reducing monthly expenses or increasing revenue. While the former may be quicker and easier, the latter should be the ultimate goal for new businesses. After all, there is a limit to how much you can reduce your cash outflows.

The reason why runway is a key metric is that it gives whatever strategy you develop the critical element of time. From the perspective of your current runway, you can asses each one of your strategic decisions and better understand how they will eventually lead you to profitability.

For example, knowing how many months of cash runway you have will inform the decision of any commercial leases, your staffing process, and any other detail of your spending strategy.

Want to Help Your Startup Survive a Recession?

With a recession on the horizon, it’s unclear what the business climate may be like for startups and new businesses. Startup companies are the most vulnerable since they typically don’t have access to a large amount of capital or lines of credit.

Knowing your numbers and cash reserves is more important than ever when trying to survive a recession, and burn rate and runway are vital metrics to help you do that. However, burn rate and runway are not the only financial reports you need to make effective business decisions. They work as part of a bigger financial dashboard that every startup should maintain to understand wether or not their plan is working.

Still, if you’re like many business owners, you’d prefer to be doing the work. The things that inspired you to start a business, not poring over receipts and crunching numbers.

That’s where Vertical CPA can help. Our experienced financial professionals can help examine your books, determine your critical numbers, and help develop a plan for making the most of your financial situation. Contact us today to get started!