How To Work Out Your Burn Rate And Runway

This week our business had another tough conversation – determining how we are going to stay afloat during the COVID-19 saga.
It’s a tough conversation that is happening in businesses all around the world; if you haven’t done it yet, it’ll happen soon.
It goes something like this:
How long can we keep everyone employed?
Who will be the first to go?
What choices do we have?
How long do we think this downturn will last?

As you can see, they’re important questions.
If you have to stand people down, you want to know as early as possible.
If you can prevent job losses, you want to know what it will take.
If you want to keep your staff, you want to know how long your money will last.
Fortunately, some simple financials can make these questions easier.
The decisions aren’t easy, but at least they’ll be clear.
We’re going to look at how you can calculate your “burn rate” and “cash runway”, or in other words, how fast you spend money and how long it will last you.

Step 1: Understanding Your Current Position
Your current position is made up of three numbers:
·      The cash in your bank account today
·      Plus the money that’s due to come in (e.g. unpaid/unsent invoices)
·      Minus the money that’s due to come out (e.g. bills, taxes and payroll)

For example, your business might have:
$310,000 in the bank
$150,000 worth of upcoming invoices
$60,000 worth of upcoming payables

$310k + $150k - $60k
= $400k as its true position today.

Step 2: Calculating Your Current Burn Rate
A burn rate is the speed at which you spend money, and it’s different for each industry.
For your business, you can use your bank transactions or accounting software to see how much you’re spending in a typical month.
This will include wages, materials, utilities, rent, insurance, marketing, etc.
Depending on how “lumpy” these purchases are, it might be worth looking at a quarter and dividing it by three to get a more honest figure.
Either way, tally up your expenses, and divide them into the logical timeframe (per week, fortnight, month).
This is your current burn rate, but we’re not done yet.

Step 3: Calculate Your Current Runway
By dividing your Current Position by your Current Burn Rate, you can roughly work out how many weeks or months you have left (if you don’t earn any more revenue).
e.g. $400k today, divided by $55k per month of expenses = 7 months
This is your Current Runway.

This is not a particularly useful figure – if you’re making zero sales, why would you keep all those expenses?
Also, do you really want to get down to your last dollar?
That’s cutting the plans a bit fine; what if you’re wrong?
You might end up in personal debt.
So even though our runway is 7 months, we need a better model to understand the future.

Step 4: Create Some Scenarios
When times become tough, you’re probably going to start cutting back on expenses.
First the luxuries, then the conveniences, then some necessities.
Hopefully in that order.
That means there isn’t just one version of the future; there are several.
There’s the version where you make minor adjustments, the version where you cut half the team and move back in with your parents, and a few versions in between.
We want to understand what all of these look like, without judging them, and with honest numbers.

For example, your rent could be $10k per month for a large office, $5k per month in a nice coworking space, $3k per month in a bad coworking space, or $0k per month in your garage.
Your payroll could change through pay cuts, dropping to a 4 day week, making some people redundant, or outsourcing some roles to cheaper countries.
And this is where the trade-offs come in.
Would you pick the worse coworking space if it prevented a pay cut?

Step 5: Review The “Levers”
I describe financial sustainability as having buffers that can absorb a shock (like losing a major customer) and having “levers you can pull” to get back in control of your destiny.
These levers are the decisions that are within your control.
For example, you control your workspace, your choice of utility provider, the headcount of your team, when to do your rebranding or launch a promotional campaign, or when to invest in staff training.
You don’t have control of COVID-19 or what it has done to your clients.
Therefore, you get to review each lever, to understand how much you can change the figures and how much of an impact your choices will have.
Cutting back on people has a huge impact on your culture, reputation and ability to serve customers, let alone what it does to the person being let go.
We don’t take it lightly.

These levers apply to revenues as well – what if you added a large contract?
What if you landed 10 smaller customers?
These levers grow your income and expenses simultaneously, and some additional deals might mean you avoid dropping other costs.

Step 6: Model The Options
Now you get to pick a few combinations of ideas and see what the numbers tell you.
For example, you can model the option of ending the year with $0 in the bank, with $200k in the bank, or $400k in the bank.
This affects how many “levers” you have to pull.
With eight months of the year left, those options become:
·      End with $0 in the bank = $50k per month burn rate
·      End with $200k in the bank = $25k per month burn rate
·      End with $400k in the bank = Spend only what you earn

If you choose to burn all of your money this year, you spare your team an early layoff but risk permanently closing the business if things don’t improve.
If you choose to stay at the same level, you’re going to pull a lot of levers and make a lot of changes, which may backfire.
If you choose to end the year with some money left, you only have to pull some of the levers some of the way, and enter next year with some cash in the bank.

Step 7: Make A Considered Decision
I can’t tell you what to decide, but I can recommend that you be honest about the choice that’s being made.
That was the outcome for us this week, we made some big trade-offs.
The trade-off of losing our perks in exchange for a guarantee of employment.
The trade-off of everyone taking a reduction in days in exchange for keeping everyone employed.
We’ll end up burning a fair chunk of our savings, but not all of it.
Better yet, we can see how additional deals coming through can put us in a stronger position, but we’re also not pretending that they’re all likely to happen.
We get to watch the numbers each month, and see how we’re tracking.

I highly recommend this process for every entrepreneur and manager.
The aim is to create clarity: clarity over the reality today, the different versions of the future, and the choices you have in front of you.
David Ogilvy said “Strategy is sacrifice”, your burn rate and runway make those sacrifices easier to comprehend.

The alternative is that you choose not to do the mental maths, and assume your gut instincts and anxieties are correct.
What’s the payoff of not thinking about it?
The problem doesn’t go away if you ignore it.
Calculating your runway scenarios is a guaranteed win:
Either your gut is correct, and now you have confirmation and a tool for checking your progress.
Or the situation is worse than you first thought, and you can take action before things get even more grim.
Or the situation is better than you first thought, and you can avoid unnecessary stress for the remainder of the year.

For more on this subject, have a look at What Is A Financial Model?, Revenue Calculations and Forecasts or go to the Financials tab in the menu.