New businesses are in a delicate situation where they are not earning revenues. However, they are spending money to invest in equipment, pay expenses, overheads, and more.
Therefore, it is very important for Pakistani startups and new businesses to keep track of the money they are spending. It is also necessary to understand exactly how much money they can spend before going bankrupt.
Burn rate and runway are two calculations that are useful in this situation. It is used by startup companies and investors to track the amount of monthly cash that a company spends before it starts generating its own income, and how long they can continue to spend that money before going bankrupt.
Here’s what you need to know to understand “burn rate” and “runway”
What is “Burn Rate”?
Burn rate is a measure of how quickly a business is losing, or burning through, their venture capital (money). It helps them understand how long they can continue spending this amount of cash before running out.
In other words, burn rate is the actual amount of cash your account has decreased by in one month. This usually describes a company’s negative cash flow.
How to Calculate Burn Rate
Calculating burn rate is very easy and straightforward, especially if you have a cash flow statement on hand.
Burn rate is calculated using the following formula:
Burn Rate = (Starting Balance – Ending Balance) / # Months
Starting balance refers to the amount of money that you have at the start of the period. This is subtracted by the amount of money that you have by the end of the term. The number of months refers to how many months are between the starting and ending balance.
Starting balance = 500,000
Ending balance = 200,000
Months = 2 months
Burn Rate = (500,000 – 200,000) / 2 = 300,000/2 = 150,000
Therefore, the burn rate is $150,000. The company is burning through $150,000 over the given time period.
What is Runway?
On the other hand, runway refers to the amount of time a company has before it runs out of cash. Burn rate is actually used in order to calculate the runway.
This is because burn rate reflects the net cash that your business burns through in a given time period. Hence, you can use that data to see how many months it would take before you “burn” through your cash balance
How to Calculate Runway:
Calculating the runway is very simple. The first step is to calculate the average burn rate, using the formula given above.
Next, you can use the following formula to calculate runway:
Runway = Total cash balance ⁄ Average burn rate = # months before you run out of money
Total cash balance refers to the cash you have on hand, while average burn rate is the amount of money that your company spends, on average, in a given time period.
Total cash balance = $600,000
Average burn rate = $150,000
Runway = 600,000/150,000 = 4 months before the business runs out of money
Therefore, the runway is 4 months long. The company has 4 months before they run out of money.
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