The definition of runway in the context of a startup refers to the estimated period of time during which the company can continue operating with available funds before completely exhausting them.
The term runway originates from the analogy of an airplane that needs a runway to take off. In this case, the “track” represents the startup's financial resources, and the “takeoff” refers to achieving key milestones, generating revenue, or obtaining additional funding.
Calculating the runway is crucial for the financial management of a startup, as it provides a clear vision of how long the company can maintain its operations before needing more capital. This allows founders and management teams to plan strategically, make informed funding decisions, adjust their business strategies, and ultimately increase the chances of long-term success.
Basic Formula for calculating the runway of a startup
It is expressed as: Runway = Cash balance/Burn rate.
Where: The cash balance is the total amount of available cash that the startup has at any given time. And, the burn rate represents the startup's monthly cash consumption rate, that is, the amount of money the company burns each month. Here the problems start, because there are actually two definitions of burn rate:
- Gross burn rate: includes only the monthly costs of the company's operations.
- Net burn rate: When a company already generates revenue, it is calculated as net revenue (sales minus sales costs), minus operating costs.
If we were to calculate the runway using the first definition in a company that is already generating revenue, we will have a more conservative but less accurate metric.
The role of financial projections in calculating the runway:
Financial projections are essential for the financial management of a startup, and there is no doubt that they play a fundamental role in calculating the runway. These forecasts, in addition to helping us to simulate what can happen and draw profitability scenarios (an example of what we like to do at Intelectium when we have at least one year of market metrics, outline and project online marketing curves, to understand how the company's margins will behave when it starts to scale), allow us to strategically plan the future of the company, by anticipating revenues, expenses and other financial factors, founders can anticipate possible challenges and make decisions informed.
In addition, they offer a long-term view of the startup's finances, by extending the projections to several months or years, the company can identify trends, anticipate funding needs and prepare for possible fluctuations in the market.
In addition, by projecting cash flow, the startup can identify times when it is likely to need additional funding. This is crucial to ensure that the company can maintain its operations without interruption and avoid running out of cash.
These projections also help evaluate strategies to reduce costs and attract investors, who value the transparency and financial strength they provide. In addition, they serve as reference points for monitoring the real performance of the startup and developing contingency action plans, thus ensuring the stability and sustained growth of the company.
In short, financial projections provide startups with a clear financial roadmap and help to predict the point at which the company could run out of cash. However, it should be noted that the uncertainty is inherent to the business environment and can affect a startup's financial projections. Therefore, it is crucial to identify these factors to develop more realistic projections and prepare for possible adverse scenarios, including:
- Changes in the market: Market conditions can change rapidly due to factors such as economic trends, changes in consumer behavior, technological advances, or even unexpected events such as pandemics. These changes can influence product demand, competition, and the startup's ability to generate revenue.
- Delays in product development: Delays in product development can have a direct impact on the market launch and, therefore, on projected revenues. Technical problems, changes in customer requirements, or unforeseen challenges can contribute to these delays.
- Fluctuations in costs: Operating costs may vary due to changes in input prices, fluctuations in exchange rates, increased labor costs, or other economic factors. These changes can significantly affect financial projections.
- Macroeconomic conditions: Macroeconomic factors, such as interest rates, inflation, and government policies, can influence financial projections. For example, higher interest rates can increase borrowing costs.
- Competition and changes in the industry: The entry of new competitors, changes in competitive strategies or industry developments can alter the competitive landscape and affect revenue and market share projections.
- Sales cycle: Projections often assume certain sales cycles, but uncertainty in the length and consistency of these cycles can affect expected revenue generation.
- Financing and access to capital: Funding market conditions may change, affecting the startup's ability to raise additional capital. Global economic problems or changes in investor perception can have a direct impact on available funding.
- Internal factors: Internal issues, such as changes in management, management issues, conflicts between team members, or product quality issues, can arise and affect projections.
By addressing these factors of uncertainty in financial projections, startups can adopt approaches such as developing scenarios, carrying out sensitivity analyses and regularly reviewing projections based on new data and developments. This contributes to more effective runway management and more informed decision-making.
How to extend a company's runway?
Increasing the runway is essential for the survival and growth of a startup. To achieve this, it is crucial to implement a series of key strategies, such as:
- Cost reduction: Identifying areas where it is possible to reduce costs without compromising quality and operational efficiency, such as renegotiating contracts with suppliers and strategic partners to obtain more favorable terms and payment terms that align with liquidity needs, optimizing internal processes or considering options such as outsourcing.
- Efficient cash management: Adopting efficient cash management practices, closely monitoring cash flows, accelerating billing to customers, negotiating payment terms with suppliers and minimizing idle balances in bank accounts.
- Diversification of income: Exploring opportunities to diversify sources of income, such as expanding to new markets, launching new products or services, or seeking strategic partnerships that generate additional revenues.
- Focus on high-value customers: Prioritizing and focusing on high-value customers that generate significant revenues, adjusting marketing and sales strategies to attract and retain more profitable customers.
- Setting realistic goals: Establishing realistic and attainable financial objectives, facilitating effective runway planning and management, and aligning expectations with available resources.
The effective implementation of these strategies can help startups extend their runway and provide the necessary margin to achieve key milestones before seeking additional funding. Agility and adaptability are key to maximizing operational time with available resources.
As we can see, the continuous monitoring of financial metrics, including the runway, is essential for the survival and growth of a startup. On the one hand, it provides a clear view of the startup's financial health in real time and makes it possible to identify and address financial problems before they turn into crises, while maintaining operational stability. And, on the other hand, it makes it possible to detect deviations in financial projections or in real performance. If the results are not aligned with expectations, continuous monitoring makes it easier to identify problems early and take corrective action.
In addition, it helps to optimize the use of resources and adapt to market conditions. By regularly analyzing expenses and returns, the startup can identify areas where costs can be reduced, efficiencies improved and profitability maximized. In the same way, continuous monitoring allows the startup to adapt quickly to market changes, adjusting sales, marketing and operational strategies to remain competitive.
And finally, by constantly monitoring cash flow and related metrics, the startup can anticipate and address any threat to the runway before it becomes a serious problem.
There is no doubt that optimizing the runway is a critical task for startups. Setting clear and measurable goals, diversifying funding sources and maintaining transparent communication are key aspects to staying on track in the right direction.
