Managing your business is the right way to ensure that it remains successful and profitable over time. One crucial aspect of this is to know and check your cash runway. In simple words, a cash runway means your business can still run before it exhausts all available cash resources. Knowing your burn rate and adjusting the cash flow forecast will allow you to extend this cash runway and avoid unnecessary risks.
You can extend your cash runway by reducing costs, optimizing payment terms, boosting revenue, or securing additional funding sources such as loans, investor funding, or crowdfunding.
In this article, we will discuss cash runways, their importance, and ways to lengthen them to help businesses maintain financial stability.
What is a Cash Runway?
The cash runway refers to the period a business can sustain its operations before running out of cash. Forecasts help predict your cash runway, and your burn rate also determines it.
If expenses exceed revenue, your business burns cash. Burn rate measures cash outflows minus cash inflows.
If your business has a $10,000 burn rate, you spend around $10,000 more than you make monthly.
Why is a Cash Runway Important for your Business?
Knowing your cash runway has the most straightforward advantage–it tells you how long your company will last without changing your spending or generating extra revenue. However, it also offers you a few more advantages:
- A roadmap for making necessary adjustments: You know that if you have six months remaining before you run out of money, modifications must be made within three to four months to avoid completely depleting your funds.
- Indicates if you’re spending too much: If you aren’t expanding your runway and your burn rate has either stayed the same or increased in recent months, you must look for ways to reduce expenses or generate more income.
- Alerts you when additional funding is needed: If you’re having trouble improving your runway and are unable to reduce expenses or boost revenue, consider other funding options to stay in business.
- It helps differentiate between profits and available cash: Profits and cash are not the same thing, and even profitable companies may have a short cash runway. Understanding your cash reserves and how long they will last helps you avoid mistaking revenue for profitability and assuming your business is financially stable.
- Boosts investor confidence: Keeping a solid cash runway demonstrates your ability to run your company, obtain capital, and draw in investment.
- Signals to reinvest in your business: If your runway is expanding and your cash reserves are increasing, consider investing that money in business expansion projects.
How can you Calculate your Cash Runway?
You must first determine your monthly cash burn rate in order to compute your cash runway. One of two methods can be used to determine your cash burn rate.
Calculating the difference between your beginning and ending cash balances for the month can be one way to look at the last month.
An alternative approach would be to review your budget, decide how much you plan to spend overall in a typical month, and then subtract that amount from your expected average revenue.
Your cash runway can be calculated by dividing your total cash reserves by your burn rate.
If your company has $200,000 in the bank and your burn rate is $50,000 monthly, running out of cash will take four months.
$200,000 / $50,000 = 4 months
It’s important to note that developing a cash flow forecast can provide a more precise estimate for your cash runway.
Forecasting will help you create a more precise projection of how you’re spending your money and when you could run out, even though using a burn rate is straightforward and helpful. Instead of calculating cash runway using average spending and revenue assumptions, you can modify your forecast month-to-month for the most accurate results.
What is a Good Cash Runway?
According to SCORE, a good approach is to keep three to six months’ worth of cash (much like a personal emergency fund). Other experts say it’s preferable to have a runway that lasts at least 12 months and possibly up to two or three years.
However, your firm, the industry’s volatility, your spending efficiency, and ultimately, your own risk tolerance will all play a role in determining how long your cash runway should be.
To determine your cash runway, ask yourself, “How long could I continue operating in this way if my sales stopped and I still had to cover expenses?”
It’s not a scientific approach, but it’s sufficient to make you consider your ideal cash runway. Just remember that if you’re not careful, having too much cash on hand can also result in several issues, such as excessive spending.
How do you Lengthen your Cash Runway?
There are several methods to lengthen your cash runway if it isn’t as long as you would like, and many of them work alongside strategies to reduce your burn rate.
- Reduce expenses: Examine your expense budget and other cash spending to identify what is definitely required to maintain your company’s operations and what can be reduced.
- Postpone payments: Examine your existing payment terms to see if any can be renegotiated or if any payments have been postponed.
- Boost your revenue: Boost your revenue by finding methods to enhance your closing rates, attract new clients, or raise your prices for the goods or services you currently offer.
- Consider recurring revenue models: Not all businesses have such an option, but creating a steady recurring revenue stream through subscriptions, reorders, or long-term contracts can increase the value of your present customers.
- Try new revenue sources: If you have not yet made revenue or depend only on one source of revenue stream, maybe you should try other ways and stop running products or services that are not doing well.
- Provide discounts: If your issue is primarily acquisition, consider lowering rates or providing pricing incentives to draw in additional clients.
- Accelerate customer payments: If you offer your clients other options for delayed payments besides cash, checks, or credit cards, consider strengthening those contracts to collect money sooner.
- Sell off assets: To boost your cash reserves, think about selling any inventory, equipment, or other assets that wouldn’t significantly affect your company if they were no longer available.
- Secure additional funding: Take into account all of your funding alternatives, such as loans, crowdfunding, investors, friends and family, or even your own funds. Just be sure it won’t put your company (or personal assets) at greater risk and that it will have a significant enough impact.
It is important to note that your cash runway is not merely a metric but, on a much larger level, the lifeline of your business. A well-planned cash runway means that you have the time and resources to navigate the challenges of daily operations, take advantage of growth opportunities, or adjust to a successful downsizing and/or business stabilization process. Most importantly, each move planned in this regard will significantly impact the financial security of an organization in the future—whether through cutting costs, modifying payment terms, or diversifying revenue generation. Taking control of your cash flow forecast informs decisions during both strong and uncertain times.
FAQs on Cash Runway
Here are some common questions and answers on cash runway:
What is the burn rate?
Burn rate is how quickly a business spends money, usually measured on a monthly basis.
How often should I check my cash runway?
To keep your business on track, analyze your available cash monthly or quarterly.
How does forecasting impact cash runway?
By forecasting, you can project income and expenses ahead of time to plan and extend your cash runway.
What are some signs that my cash runway is running out?
Signs include late payments, a higher burn rate than expected, and a decrease in sales or revenue.
Can increasing revenue help extend my cash runway?
Yes, you can increase cash flow by launching products, offering subscriptions, or improving collections.
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