Cash Runway: Meaning, Formula & Key Strategies
Côme Chevallier
Sep 5, 2024
If you’re a business owner or a financial officer - especially if you work in a startup -, you know things have taken a turn recently. In recent months, the economic context has changed and businesses have had to change their optics.
When VC-funding was almost a given these past years, it has altered drastically in the past few months. Capital isn’t cheap anymore and investors are looking for profitability more than exponential growth. That leaves small businesses - startups and scale-ups alike - desperately trying to get a good hold on their cash flow before it’s too late.
Cash runway is more than ever a focus for finance teams and business owners alike. It indicates how long you have before running out of cash - and running into serious trouble. Basically, a low startup runway means you might not have enough money to survive.
The good news is that strategies do exist to extend your cash runway and they don’t always mean laying off team members. Keep reading to discover:
Our finance leaders from Malt, Lattice, and Upflow are happy to guide you through this crucial challenge with unique content! Check out our webinar for insightful tips.
What does Cash Runway mean in Business?
Cash runway is the number of months you have left worth of cash if you keep spending at the same burn rate. Basically, the higher it is, the better! A high runway means your business is in good financial health and has a good handle on its cash flow management.
On the other hand, a low startup runway can mean several things:
You’re burning cash too quickly and might need to audit your main expenses
You’re not profitable and rely heavily on funding (which might not come)
Once you’ve reached the end of your runway, things might get messy.
In this time and age where capital is more expensive and investors more cautious, having a high cash runway is necessary - albeit not enough - if you want to raise funds. Venture capital funds aren’t looking for exponential growth anymore: they’re looking for stable and profitable companies. That’s what a good cash runway indicates.
VCs still have capital to invest, however, in today’s market they are much more cautious about how they spend it. This is one of the reasons why it is much harder for startup founders to secure rounds of funding.
In today’s ecosystem, businesses need to be profitable, and the mantra of growth at all costs is no longer relevant. Investors are also looking at the efficiency of your business. Repeatability is important but your business first and foremost needs to be efficient. This is because something repeatable in the past may not work in the present. That’s why your business needs to be efficient in adapting to its current environment.
If you are in a startup that operates in a volatile industry, such as crypto, investors will be even more cautious with their investments. Consequently, these businesses need to take extra precautions when it comes to their startup runway and implement efficient and result-driven processes for cash collection.
Business valuation has also significantly dropped in recent years, especially in the tech industry. What this means is that for the same amount a company raises, for example, 30 million, if the valuation has gone down this represents a significant dilution. This means that in later rounds of funding your business will probably raise less capital because of your decreased valuation.
With this in mind, businesses need to be smarter and more cautious about how they are spending and keep a close eye on their monthly cash burn rate to avoid a negative cash flow. In sum, the amount of funding available to companies has decreased and is harder to attain. That’s why investing and implementing effective mechanisms to protect your cash reserves and extend your cash runway is crucial.
The Formula to Calculating Cash Runway & Cash Burn
Calculating this metric is easy enough. Start by checking out your bank account and how much cash you have on hand. Divide this amount by your cash burn rate and you’ll get the months of cash you have left. Cash runway formula:
Cash runway formula = Cash Balance / Cash Burn Rate
To calculate your cash burn rate, you need to subtract the total amount of cash your company spends in a month from the cash it brings during that same month. Cash burn formula:
Cash Burn Rate formula = Cash Received – Cash Paid Out
Cash runway is one of the many financial indicators that you should track as a B2B company.
A question often asked is, How much runway should a startup have? A good startup runway depends on the growth stage you are in. Two years ago, if your business was in its early stages and had just raised, you’d typically would have wanted to aim for a 2-3 year runway. However, in today’s context, you’d want that to be much longer. In any case the more months of cash runway you have the better it is for your business. Generally speaking, the rule of thumb to follow is 3 years.
As a business owner, your goal is to steer clear of a runway that falls below 12 months. With a runway of under a year, you can consider yourself in a danger zone. Being in this zone means that you have lost some control over your business’s trajectory. Falling under this time bracket can leave you in a tricky situation as it does not give you enough time to anticipate any possible changes you might need to perform, such as raising capital, changing strategy, or in a worst-case scenario selling to save your business.
Lastly, the number of months of cash runway you have under your belt can be used as bargaining power. If an acquirer or an investor knows that you only have a few months left of cash it will leave you with less leverage to negotiate. You’ll be backed up in a corner with fewer options on your side.
3 Ways to Extend your Cash Runway
Funding used to be a common way to improve your cash runway. However, now that obtaining additional funding is getting complicated, you need to find other strategies if you want to have a healthy cash position. There are three main pillars to improve your startup runway:
Generating new revenue
Controlling your outflows by prioritizing and cutting expenses
Increasing your cash inflow by improving your accounts receivable management
Cash collection can quickly improve your runway: As an example, going from an 80% to 140% collection rate can double your cash runway in a few months. Do you want to see how it could work in your business? Check out our free spreadsheet that calculates your runway, as well as the impact cash collection, can have on it.
Generating New Revenue to Extend Runway
This seems like the most obvious one, but it’s definitely not the easiest, especially in a crisis. Generating new revenue for your business could be:
Leasing or subletting offices: If you don’t need the space, you might as well make some money out of it.
Create new partnerships: Partners can help you gain new clients by addressing their own audience and promoting your product and services in exchange for your own promotion efforts. It’s a win-win situation!
Adapt your pricing grid and business model: There’s nothing wrong with upping your prices, especially if you haven’t done so for a long period of time. As long as it’s justified by relevant new features or services, your customers will relate. Check out our advice on pricing models for SaaS.
In a difficult economic climate coupled with tougher barriers to capital, businesses need to orient the messaging of their product to the value proposition they can offer. For instance, SaaS businesses need to commit to the value they claim to offer and must deliver upon it.
On top of that CFO’s should be part of every single conversation. Why is this? Because companies are currently trying to reduce costs and are not buying new software. Thus your pricing needs to be tightly aligned with the value you provide.
Switch to a subscription pricing model: Nowadays, companies are trying to protect their revenue by not necessarily diversifying their activities but changing their pricing model. Many businesses are rethinking their model and moving towards subscription-based services as opposed to one-off services. This strategy helps extend your startup runway. Moving towards a subscription pricing model is an accurate representation of what companies are currently doing to adapt to today's market factors. A subscription model protects your business because it is recurring revenue. There is always a risk of churn, but this type of model mitigates this risk and gives businesses a guaranteed stream of revenue as opposed to one-off sales.
Offer specific discounts: If it’s harder to acquire customers, give them extra incentive to sign. That could be specific discounts: for example at Upflow, we offer discounts to new clients in exchange for customer stories.
Having said that, don’t be so quick to jump on offering discounts. Your goal should be to close deals thanks to focusing your pitch on the value proposition that your product or service will offer your customers. It’s also suggested you only offer discounts in exchange for a longer commitment period. Longer commitment deals have greater value for your business as it increases your MRR and in turn your cash runway.
It’s also interesting to note that many companies make it their strategy to focus on their current customer portfolios and aim to secure renewal contracts and also extend contracts long before they come to an end.
For example, Lattice - a SaaS specialized in people management - released two new products over the past months and increased its pricing for the first time in months. Jason Lopez, controller at Lattice explained that freed up new revenue and reduced the dependency on the existing product.
On their side, Malt changed their legal framework to increase their responsibility - and pricing - for companies. All those strategies resulted in more cash inflows and a healthier runway for these scale-ups.
Unfortunately, it’s often much harder to head this way than to take the “cutting costs” road.
Cutting Costs and Controlling Your Accounts Payable
As we’ve seen in recent news, many start-ups and scale-ups have cut costs by massively laying off their staff. According to Sifted, BitPanda laid-off 34% of its staff and Klarna about 10% - only for summer 2022. These are only a few names among the many casualties among startups and scale-ups.
Laying off is unfortunately one of the resorts to cut costs. But before getting there, there are a few other alternatives that can help you control your APs.
Prioritize expenditures
Make a list of all that’s going out from your bank account and prioritize from most to least vital for your company. Prioritize costs that have a higher ROI and cut the expenses that are less profitable: at Upflow for example, we cut the marketing costs in priority.
Prioritizing will help you reduce overspending drastically! You’ll find out that many additional expenses can actually be cut altogether, leaving more cash for vital operational expenses.
At Upflow, our finance director Alexandre Antoine has set up a regular tool audit to make sure team members actually use the tools we’re paying for and we’re not losing money over unused software. It’s definitely helped cut costs, even making processes easier sometimes (we know how it can get when there are too many tools!).
Tightening travel expenses is also an excellent way to reduce your costs. That’s what Nicolas Roux, CFO at Malt, set up in his own company, setting strict rules and calling on the responsibility of each and every team member. Having the right expense management tool can definitely help with this.
Talk to vendors and negotiate terms
Business is all about relationships. You might be surprised how far a good business relationship can go. It could be setting up a payment plan, changing the payment terms, or even lowering the pricing: talk to your suppliers and find a solution that works for all. At Upflow we’ve prioritized yearly plans, which has had a direct impact on our cash runway.
Hiring freeze
Rather than laying off, a hiring freeze will stabilize your HR costs and your payroll. It’s a good - albeit temporary solution - to balance your costs.
All in all, make sure you prioritize and think of all possible costs to cut before moving to lay off team members.
Tightening your Accounts Receivable Process
Reducing cash that goes out is one thing: increasing cash that comes in is another option! This means tightening your grasp on cash collection to make sure your clients pay you on time and your cash balance is positive.
Accounts receivable management really is a central piece of the puzzle when it comes to having enough cash! The good news is that it’s our specialty at Upflow: we offer a dedicated cash collection solution that will get you paid on time.
There are many AR best practices, such as:
Setting up a proactive strategy: Be proactive! Don’t wait for a payment to be past due to ask for it. Set up a strategy to get paid from the start of your business and see it through. This means having a systematic process in place.
Having crystal clear billing policies: The simpler it is to pay you, the quicker your clients will actually pay. Have crystal clear billing policies and procedures, documented and followed by everyone in your company.
Customizing your communications: In cash collection, sending generic payment reminders is a big no. Segment your client base by client behavior, geography, or size and send personalized emails accordingly.
Tracking your AR metrics closely: It’s important to start by having a look in the mirror. And that means tracking KPIs like DSO, aging balance, or CEI. This is where having an AR tool like Upflow comes in handy as they generally offer real-time access to metric dashboards.
Involving the business team: Sales executives generally have had many contacts with clients during the sales cycle. It’s always a good idea to keep them or the account managers in the loop when a client hasn’t paid and isn’t giving any news.
Implementing AR software: Automating your collection with software like Upflow will help you get paid quicker and reduce the amount of time spent on manual processes. Our solution sends out automated yet personalized email reminders to clients and offers access to extensive and reliable metrics.
At Upflow we’ve been putting a lot of effort into cash collection these last few months. We’ve really made it a central stake in the company, communicating as actively on collection as on new deals.
Our finance director, Claire Somer, implemented different steps to incentivize upfront as well as yearly payments, making the sales team a main player in collection efforts. The result? We’ve extended our cash runway by several months!
Key takeaways
Cash runway is crucial, especially in this economic downturn where getting additional funding rounds is more complicated. Fundraising isn’t part of the given anymore and companies have to adapt!
There are many ways to extend your cash runway and have a positive cash flow before lay-offs. The main three pillars are generating new revenues, cutting costs, and controlling your AR.
You can lease offices, create new partnerships, or adapt your business model and pricing to generate new revenue.
Reducing costs isn’t only about payroll: start by prioritizing your expenses and talking to vendors about payment terms.
Cash collection can have a big impact on your runway: by improving your cash collection you might be able to extend your startup runway by several months.
AR solutions like Upflow will help you get a handle on your cash collection by offering live metrics and sending out personalized email reminders. It will reduce manual tasks and leave more time for strategic decision-making.
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