How do you calculate burn rate, runway and growth rate?

The beginnings of any business may be the most exciting but also the most difficult. 

When founding a startup or building a new business, you have many duties: creating a great product or innovative service, hiring the right team for it, contacting investors and, of course, managing your finances. 

Managing finances can sound overwhelming or complicated at first. However, once you learn the three basic metrics, burn rate, runway and growth rate, you get a crystal clear view of how your business is doing economically and can make better decisions for your business's well-being.

Besides, when you're pitching to investors, it is safe to say that they will ask some of these metrics about your business, so you'll want to know how to calculate them to have them at hand for these critical moments.

So, to help you understand and calculate these three metrics, we'll show you everything you need to know about them.

Keep reading!

What is Burn Rate?

Burn Rate is a metric used to calculate the cash your company spends before generating its income. It is the rate at which you use your available money each month. 

Now, interpreting the results of a burn rate is not about something as simple as saying that a lot of spending is terrible and little is good. It's a bit more significant, and that's why it's good to study. With the result of this metric, you can decipher the following:

• What should you spend on?
• When should you spend it?

As Efrat Kasznik explains in a Silicon Valley Bank article, the thing with burn rate is not about telling how much you spent and how long will the money in your bank last (this has to do  runway, more on that soon.) Instead, your burn rate value will let you know how you're performing and how your expenses could change as your company grows.

 Larry Augustin, a founder, CEO and board member of many startups since the mid-1990s, says that many startups fail because they plan on how they'll spend their subsequent funding when, in reality, they might not get it. Instead, he tries to tell us that the burn rate helps us better use the money we already have. In a few words:

"Managing burn rate is a way to give yourself options."

Why is Cash Burn Rate important for Startups?

Venture investors know that all early-stage companies tend to fail once they spend all their funding, so they are unwilling to contribute to the ones that know how to manage their money. A startup that depends only on the next fund is considered a high-risk one for them. 

So, you want your startup to be more attractive to investors. In that case, you have to understand your business's spending needs and liquidity, so you and your subsequent investors have more clarity for decision-making.

To know the actual liquidity of your startup, you also need your resulting runway but do not worry we will explain everything about this later (Promise).

As you track your monthly cash burn, your startup benefits from gaining insights on:

• Your spending needs.
• Get a better plan if you get new funds.
• Identify the costs associated with financing operations and how you can use your revenue level to generate profit.
• You can determine how long your company has to work on product development.
• Compare spending efficiency and see how it translates to output.

Besides, when asking for funds from an investor, we'll ask about the three metrics within this article, and because of this, we'll show you how to calculate the first one.

How to Calculate Burn Rate?

There are two types of burn rates: gross and net burn rates.

The first one, gross burn rate, refers to the total expense for each month. Its formula is as straightforward as possible, being:

Gross Burn Rate = Monthly Cash Expenses.

The net burn rate shows you the total amount of money your company loses each month, considering any other revenue you could get. For this formula, we have:

(Monthly Revenue - Cost of Goods Sold) - Gross Burn Rate = Net Burn Rate

Factors that affect your Burn Rate.

• Layoffs: One of the most significant expenses for any new company is its salaries, so you must evaluate that your salary expenditures are fully utilized.
• Downsizing: This factor concerns your expenses and how you could reduce them. For example, are you paying for spaces and amenities you must use? This could be an expense you can eliminate and give a new air to your business.
• Client Churn: As more clients abandon your startup services, it will reduce your monthly income. The idea is to build a strong relationship with them through digital marketing strategies so they prefer your company over the others. If you want help with this, 
  contact us!

What is Runway?

Runway refers to how long a company can operate before running out of cash, typically measured in months.

When you track this metric, you can understand how long your business has to achieve the next milestone before it needs more funding.

With burn rate, you can understand how your money is behaving, and money is the lifeblood of your business, while runway rate lets you know how long this money will keep your business alive.

If your burn rate keeps growing and your runway rate is diminishing, you quickly notice that there are some changes you have to make.

Investors will likely see your option as viable if you have a reasonable burn rate and more than 18 months of healthy business life. But how can you calculate it, and what is a good runway for startups and businesses?

How to calculate Runway?

Calculating your Runway consists of taking your total amount of cash and dividing it by your burn rate. In a formula:

Cash Runway= Total Cash/Net Burn Rate.

Now what is a good Runway? Well, at first, you could say that a Runway value of twelve months or less is something in which you should start taking action ASAP. Now, as a Mosaic article says, startups could get by with a significantly higher Runway of 15 to 18 months after their first fundraise. Nevertheless, considering the recent market, investors find more suitable companies closer to 25+ months of Runway. 

Factors that impact Runway

• Fundraising: Fundraising significantly impacts your Runway as it gives you more money to spend, ultimately increasing the time you can stay in operation.
• Receivables: The reason behind a low Runway may be delayed payments from clients. If this is the case, please remind them of their payment terms.

How to extend your Startup Runway and reduce Burn Rate?

Now that you know how to calculate these two important metrics, it is a good idea to find the most effective ways to reduce your burn rate and other expenses to expand your runway. Let's see what are these ways to do it:

Drive More Sales

This way may be obvious and also easier said than done. But we are giving an alternative for it. Just keep reading.

Any startup and business goal is to drive more sales, which is also suitable for the two metrics we already talked about as, in one way, it increases your business earnings, giving your business more lifetime.

Now, the best way to drive more sales isn't about spending too much on new updates or more merchandise but rather learning the best way to promote your business to the right people. And, of course, the best way to do this is through a digital marketing agency.

In Codedesign, we focus on the characteristics and needs of our clients so they can get a personal strategy for their brands. Every business needs a different approach, as there isn't a unique strategy that fixes all purposes. If you want personal attention for your business, contact us and let us help you!

Cut non-essential expenses

Another easy way to extend your Runway is by cutting those expenses that may be just a whim or even a spent in a strategy that isn't working. The downside of this approach is that cutting some costs could affect some operations within your company. Nevertheless, this scenario can be different, as you can study what expenses are unnecessary and won't affect your teams' performance.

For example, you could be spending too much money on a digital marketing channel that isn't working because your audience isn't in there.

If we talk about an office, you could save money while trying remote work. 

Look out for other funding options.

Of course, looking for financing options will always be great for startups. Nevertheless, as mentioned above, a financing option doesn't replace a good financing study, so take care of it.

Meanwhile, venture debt could be a suitable option for your business if you are a startup founder or working with a new business model and don't have too much credit history for a bank loan. To learn more about this financing model, check out our article explaining this financing model.

What is the Growth Rate?

Also known as Revenue Groth Rate, this metric measures the month-over-month revenue increase. This is one of the most critical KPIs for startups and new businesses to be aware of.

How to calculate Revenue Growth Rate?

To calculate your business' growth rate, subtract the first-month revenue from the second one. Then, multiply the result by the first month's income by 100 to get the desired percentage. To make it more visible for you, this is the written formula:

[ Second Month Revenue - First Month Revenue ] /  First Month Revenue X 100 = (%) Revenue Growth Rate

What is a good growth rate for a Startup?

The good thing about Revenue Growth Rate is that it gives you a better context of your business progress by comparing performance each month. This is a more solid value than comparing your current or total revenue. 

And since many startup founders aim to pitch their idea to investors, you can be sure that anyone who sees that your growth rates are pretty good will have further validation to want to be part of your venture.

Now, we have to announce something about the growth rate. You see, at the beginning of any business, after you get past the existence and survival parts, entrepreneurs get excited because their growth rate can grow a lot between months.

However, over time these growth values drop and even stagnate if you want to say, and you can go from growth of 150% to 80% for the following measurements. This is nothing to worry about. As companies mature, it is normal for the growth rate to stay at a steady point where there is not much change. Some experts suggested that a growth rate between 15% and 25% is stable. However, to reconfirm your results, you can measure more extended time frames, anywhere from 12 to 18 months, to see if your growth is progressing or just a one-time exponential growth curve.

Final thoughts.

As a founder or owner of a new business, learning how to calculate your most important financial metrics helps you understand how to manage your money so that your business can continue to grow or stay comfortable.

When you calculate the burn rate, you understand how you are spending, especially if those expenses are worth it or if you could remove them. Then, runway rate gives you a long-term view of the "lifetime" of your business based on what you carry, giving you a more accurate clue as to whether things are going well or whether you should change course, or, As a last resort, opt for one more funding.

In any case, you should know that if you want to qualify for funding for your business, investors need to know about these metrics since they will not take risks with companies in deplorable conditions or that only depend on loan on loans.

Therefore, also make sure to calculate your growth rate to draw the conclusions you have to draw about the performance of your business, and in the best case scenario, have all the values up to date to qualify for funding safely.

At Codedesign, we are the source of information for any type of startup or digital business that wishes to grow professionally. If you want more advice, contact us!

FAQS - Frequently Asked Questions

---