Imagine you’re an architect and you’ve been hired to design an airport. What do you think would be the most critical element overall?
Yes, you’re right- the runway is undeniably the most important infrastructural element when it comes to airports. Its design determines what type of planes will be able to land and take off from the airport.
If yours ends up being too short, therefore, the facility won’t even host planes. Takeoffs and landings would be impossible.
But, that’s not to say the runway should be extremely long. Extra allocations translate to additional project costs, which would also make the airport unattainable. In any case, you should consider all risks before taking any decision. And your readiness to risk is important in this case, as well.
Now that’s pretty much the same principle when it comes to startups. A runway essentially refers to the number of months a business would survive before eventually running out of funds.
Interestingly, 65% of successful small business startups did not believe they had sufficient funding while they were getting started. About 33% of them began with less than $5,000, while 58% were in the less than $25,000 bracket.
And their runway? Well, with such limited startup funding, it’s no surprise that 93% of them had runways of less than 18 months. But, they managed to hold on and stay ahead of the runway through proper planning as well as cost reduction practices.
Now, if you intend to facilitate your startup in a similar manner, the planning process starts by establishing your specific runway.
How Do You Calculate A Startup Runway?
To determine your startup runway, you need to begin with the Gross Burn Rate and then the Net Burn Rate.
Gross Burn Rate
The Gross Burn Rate is the average amount of money used by your startup on a monthly basis. If, for instance, you end up spending $240,000 within 12 months, your Gross Burn Rate would be $20,000 per month.
Therefore, the Gross Burn Rate formula is:
- (Principal Cash Balance — Leftover Cash Balance)/ Number of months = Gross Burn Rate
Net Burn Rate
The Net Burn Rate, on the other hand, refers to the difference between funds inflow and funds outflow. This, in other words, means subtracting the average amount of monthly income from the Gross Burn Rate.
Hence, if your startup made $60,000 in 12 months with a Gross Burn Rate of $20,000, the Net Burn Rate would be $15,000 per month.
And here’s the Net Burn Rate formula:
- Gross Burn Rate — Average Monthly Cash Influx = Net Burn Rate
Then finally, the startup runway is calculated by dividing the principal cash balance by the corresponding Net Burn Rate. Hence, dividing $360,000 by $15,000 would give you a runway of 24 months.
The precise formula is:
Principal Cash Balance/Net Burn Rate = Runway in months
And that’s all it takes to calculate the startup runway. Once you’ve determined yours, find ways to minimize the burn rate and you’ll ultimately extend your runway period.
Afterwards, you will need to set up your accounting system and to get everything in place, we recommend you to hire an accountant or CPA. It should not be a full-time worker, you can find a freelancer from an outsourcing company, so it will not cost too much and it’s better not to start too late.
If you are planning to play a long-game, we suggest you hire a CPA who focuses on startups. First of all, they have to pass one of the most difficult exams and learn a bunch of stuff (for example, check this list of preparation courses to get an idea). Also, they are more experienced in planning your deductions, analyzing your financial data and helping to make well- balanced decisions.