(Re-) Calculating Your Cash Burn Rate in a Downturn
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So you started this year with everything figured out: you had a manageable cash burn rate, you had a clear amount of runway, and you had a business strategy built around both. All of a sudden, there’s a downtrend in the stock market, supply chain issues are eating into revenues, talks of a recession are growing louder, and companies of all sizes are implementing cost-cutting measures, such as layoffs and hiring freezes.
So what do you do now?
There’s a number of steps that startups can take to manage their financial position in a downturn, but we’re going to focus on the fundamentals: calculating your new burn rate and runway.
Calculating Burn Rate
The actual math for getting your burn rate is pretty straightforward: you subtract your cash balance at the end of the month from your cash balance at the beginning of the month, to get the amount by which your cash balance decreased. That amount is your burn rate.
By examining your average monthly cash burn, its trajectory, and how much cash you have on your balance sheet, you can estimate how much runway your company has to work with, i.e., how long you have until you run out of money (and we actually have a burn rate calculator to help you with this).
The problem you’re likely facing now, of course, is that the numbers that went into those previous calculations are now changing significantly. While some segments are more affected than others, virtually all businesses are likely to experience at least some impact from an economic downturn.
Getting Your New Numbers
It’s unfortunately safe to assume that customers are more likely to churn and it will be tougher to make new sales. This translates into downward pressure on your top line which increases your cash burn as your expenses stay the same. And with increased burn without new capital injection, you will have a shorter cash runway.
Updating your burn rate and runway means re-running your calculations with new numbers. To get those numbers, however, we have to take a step back. You need to have a solid model for making projections, so you can factor in how revenue, churn, and spend over time will impact your burn rate and runway. And to do that, you have to have clean books.
We’ve talked before about how clean books are crucial for making good business decisions (and we’re not just saying that because bookkeeping is our business). Your books are the ultimate source of truth for your company’s financial status – they tell you how much cash you have, what your assets and liabilities are, and where your company’s money is going. If you can’t trust the accuracy of your books, then you can’t be sure that your financial decisions are based on reality. In the current economic climate, this is more important than ever.
Estimating Your New Runway
When you’re confident your books are accurate, you can pull the numbers you need to re-run your financial models. Use these figures to get new revenue and churn predictions based on the current market, which then gives you a new projection for how much cash you’re likely to bring in. Finally, use that cash projection vs. your expected expenses to recalculate what your burn rate is likely to be for the next months or year.
It may be more difficult to fundraise during an economic downturn, you should generally ensure that your startup can remain solvent for the next 24 months without any additional infusion of capital.
Given the current uncertainty around the pandemic and the markets, you should consider running numbers for multiple scenarios. What might your numbers be in a month if the situation continues to deteriorate? What might they be if it stabilizes? This is where a sensitivity report for your current models is helpful. Here’s a simple example for a company with $100,000 cash in the bank and $10,000 in monthly expenses, examining how its cash burn and runway change with different levels of revenue.
Doing this kind of analysis upfront helps you plan for situations that you may face, so you aren’t caught off-guard if the market continues to shift. Regardless of what the economy means for your original plans, you’ll be in a position to start making decisions about what your business needs now.
Check out these other helpful resources as you navigate these times:
- How to Reduce Your Startup’s Operating Expenses
- How to Approach Budgeting During an Economic Downturn
- Founder to Founder: Advice for Navigating the Downturn