What should I include in runway calculations?

Understanding Runway Calculations: What to Include and Why It Matters

Every financial journey involves planning and foresight, and calculating your runway is a crucial part of this process. Whether you're managing a business or your personal finances, knowing how long your resources will💡 Definition:A will is a legal document that specifies how your assets should be distributed after your death, ensuring your wishes are honored. last can save you from unexpected financial stress. This blog will walk you through the essential components of runway calculations, offering practical examples and highlighting common pitfalls to avoid.

Key Components of Runway Calculations

Current Cash Balance

The starting point of any runway calculation is your current cash balance. This figure should include all liquid assets💡 Definition:Assets that can be quickly converted to cash without losing value—like savings accounts, stocks, and money market funds. such as:

Cash on hand
Savings accounts
Taxable brokerage accounts

These assets are readily accessible and can be used to cover immediate expenses. It's crucial to subtract any short-term liabilities like credit card balances or upcoming payroll obligations to get an accurate picture of available cash.

Net Burn Rate

Your net burn rate is the monthly cash outflow after accounting💡 Definition:Accounting tracks financial activity, helping businesses make informed decisions and ensure compliance. for all revenues. It's calculated as:

[ \text{Net Burn Rate} = \text{Monthly Expenses} - \text{Monthly 💡 Definition:Income is the money you earn, essential for budgeting and financial planning.Revenue💡 Definition:Revenue is the total income generated by a business, crucial for growth and sustainability.} ]

For instance, if your monthly expenses are $150,000 and your revenue is $50,000, your net burn rate would be $100,000. This figure helps determine how quickly you're depleting your cash reserves.

Runway Formula

Once you have your current cash balance and net burn rate, calculating runway is straightforward:

[ \text{Runway (months)} = \frac{\text{Current Cash Balance}}{\text{Net Burn Rate}} ]

This formula gives you the number of months you can sustain your current operations before running out of cash.

Practical Examples

Consider a startup💡 Definition:A small business is a privately owned company that typically has fewer than 500 employees and plays a crucial role in the economy. with a $250,000 cash reserve💡 Definition:Savings buffer of 3-6 months of expenses for unexpected costs and financial security., $90,000 in monthly expenses, and $20,000 in monthly revenue. The net burn rate is $70,000, leading to a runway of approximately 3.6 months.

Another example: A company with $500,000 in cash and a $100,000 net burn rate would have a 5-month runway. Alternatively, a SaaS business with $200,000 cash, $50,000 in sales, and $30,000 in expenses nets a $20,000 burn rate, suggesting a 10-month runway.

Common Mistakes and Considerations

Relying on Single Month Data

Expenses and revenues can fluctuate, making it risky to base calculations on a single month's data. To mitigate this, average your burn rate over 3, 6, or 12 months to account for seasonality and irregular expenses.

Ignoring Scenario Analysis💡 Definition:Simulating extreme market scenarios to see how your portfolio would behave during crashes, recessions, or rate spikes.

Runway calculations should consider different scenarios:

Base Case: Assumes average, expected conditions.
Conservative Case: Accounts for unexpected expenses or revenue shortfalls.
Downside Case: Prepares for worst-case scenarios, like economic downturns.

Overlooking Revenue Quality

Distinguish between recurring revenue (like subscriptions) and one-time sales. Recurring revenue provides more stability, enhancing the reliability of your runway.

Not Planning for Market Conditions

The fundraising environment and capital market conditions can impact how long your runway should be. In less active markets, aim for a longer runway to provide a buffer.

Bottom Line

Runway calculations are more than just numbers—they're strategic tools that forecast financial sustainability. By including current cash balances, calculating a realistic net burn rate, and using scenario analyses, you can develop a more accurate picture of your financial future. Remember, a runway is a dynamic forecast, not a guarantee💡 Definition:Collateral is an asset pledged as security for a loan, reducing lender risk and enabling easier borrowing.. Always be prepared to adjust your strategies based on changing circumstances. By following these guidelines, you'll be better equipped to manage your personal or business finances proactively.