After the rocky economic climate of the last year, it’s clear to many business owners and entrepreneurs that tough times may 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.
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 period, usually a month.
This money is being spent out of the organization’s initial capital and is used for things to grow your business, including:
- Hiring and paying staff
- Renting office space
- Buying equipment or supplies
The simplest way to determine your business’ 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 important 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 burn rate. To find the gross burn rate, you’ll just need to total up all the expenses of the period.
This is only a measure of spending, 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 then subtract any cash inflows or other revenue.
This gives you a true picture of the cash amount you’re losing each month.
As your revenues increase, 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.
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 expresses how long your organization’s cash reserves will last at current burn rates before you go broke 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 calculation.
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, but in others, the end of your runway could mean closing the curtains for your startup.
This is why it’s so incredibly important to understand – runway provides you with a definitive date to turn things around by.
Extending Your Runway
The easiest way to extend your runway is to reduce your burn rate, either by reducing expenses or increasing revenue. While the former may be quicker and easier, the latter should be the ultimate goal for new businesses.
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.
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.
Still, if you’re like many business owners, you’d prefer to be doing the work 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!