Cash is king.
These are the words that resonate most with CFOs ever since the market plummeted, leaving us in the tenth worst downturn since 1929.
Do you know what they did in 1929? They learned to stretch their meager resources. The great depression lasted ten years and saw the emergence of the notorious “depression era cooking”. Baking a cake with applesauce instead of butter saves costs and results in an edible cake.
But what if apples are harder to source than butter? In other words, how do you formulate a strategy to extend your cash runway, specific to your situation?
Read on for advice on how to adjust to the downturn while maximizing profits and extending your runway.
What is cash runway?
Cash runway measures the amount of time your company has left to sustain itself before running out of cash.
Runway is generally represented in months, for example: say a business has 12 months of cash runway. This indicates that the business will run out of cash in 12 months, if it continues operating in the same way.
Let’s take a look at the formula in detail:
How to calculate cash runway
The cash runway formula is simply your cash on hand divided by your net burn. Here’s an intuitive way to think about it: your runway is the number of months it takes to burn your cash, assuming you burn the same amount each month.
A practical example to calculate cash runway
For a practical example, imagine a fast-growing tech startup that recently raised $40 million, and generates about $4 million ARR. The company has doubled its headcount in the past year, as well as invested strategically in research and development, sales, and marketing. All in all, we’re looking at a monthly net burn of $1 million.
If the company continues to burn at the same rate each month, it’s safe to say that the company will run out of cash in about 40 months, if no new rounds of funding occur.
The resulting 40 month cash runway is calculated by dividing the monthly cash balance of $40.3 million by the monthly $1 million cash burn.
What is a good cash runway?
Cash runway can vary wildly based on the maturity of the business, the industry you’re in, and the market situation over all. That being said, here are a few guidelines for a “good” cash runway by funding stage.
The best way to think of your cash runway is by framing it as a period to strengthen and accelerate what works, while pruning investments that don’t generate the expected result. Companies respond to dwindling cash reserves by raising capital.
To further understand this, it’s important to note the concept of negative cash flow.
What is negative cash flow?
When a company has a negative cash flow, it indicates that the company is burning more than they are generating. In other words, negative cash flow is the state of higher operating expenses than revenue generated in any given time period.
Negative cash flow is commonly referred to as cash burn.
Now, having a negative cash flow isn’t necessarily a bad thing. For example, it could be a conscious decision for a disruptive technology player entering a crowded market to pump up their sales & marketing spend to quickly increase market share and spread brand awareness.
The problem occurs when the path to ROI is longer than the expected time to either the next funding round, or an exit event. This is further compounded by market downturns and recessions, as funding is scarce to come across and investors steer towards low-risk investments.
In situations where cash flows are negative and funding or exit isn’t likely to happen in the short term, companies cut costs in the hopes of extending their runway. But is cutting costs the only viable path to a longer runway?
Three different strategies to extend your cash runway
As noted earlier, it’s impossible for any strategy to be effective in every scenario. Extending your runway should be based on the decisions that are best for the health and morale of your business in your particular context.
In the current climate, it can be hard to come across external funding. Although debt and capital can be helpful, this is not the only path to positive cash flow.
Instead, you can look at extending your cash runway as a mindset shift - and these three areas of focus will help concentrate your efforts on strategies with the highest impact:
Leverage scenario planning
Scenario planning is a methodology that assesses the impact of each possible best case and worst case decision in the future.
Since the onset of the pandemic and the more recent economic turmoil, companies increasingly turn to scenario planning. This is one of the best tools to predict and plan for the future and avoid unpleasant surprises.
So how can you extend your cash runway through scenario planning? Essentially, you turn your best guesses into data-driven confidence. This results in faster decision making that is likely to receive buy-in from all stakeholders, since it is based on evidence grounded in reality.
For example, say you’re contemplating a headcount reduction. Decisions such as these have strong consequences on people’s lives as well as company morale, and as such should not be taken lightly.
Scenario planning can be your tool to determine how much, if at all, headcount you need to reduce to further extend your runway. Not only does it help you make difficult decisions, scenario planning also helps you determine where to invest and cut back, based on forecasts.
Do not forget to read our starter guide to scenario planning, which is packed to the brim with detailed examples of scenario planning during uncertain times.
Position yourself as a Finance business partner
We’re all aware that the traditional role of Finance is evolving like never before, along with the increased velocity of forecasting and reporting processes and tools. The Finance team plays a key role as the CEO’s partner in navigating turbulent times.
By positioning yourself as a strategic business partner, you help influence the company culture by encouraging closely monitored spending, impact assessment of each investment, and maintaining strong unit economics.
In particular, it can be very tempting to raise funds during turbulent times, for all the wrong reasons. As a Finance business partner, your role is to ensure that founders raise at the right time, with a clear objective and plan for converting raised funds into ARR.
Finally, as a business partner, your role is to align the entire organization in the mission to extend your runway. Whether you choose to freeze hiring, cut discretionary costs and travel, or introduce a formal purchasing process, communication can make or break the success of your initiative.
As the team closest to the bank account, your duty lies in ensuring that every employee understands their role in the long-term sustainability of the company.
Build a foundation of data literacy
Fear of data is real.
At times, it’s hard to know where to start, especially with the wealth of data that exists today. Moreover, Finance leaders often find it hard to source accurate and timely data, let alone a consolidated source of truth.
When you spend most of your time on data wrangling, you lose out on actual insights from analysis. By implementing a data architecture of trusted sources, effortless imports & exports, and rapid insights, you replace fear of data with confident decision making.
Coming back to our primary focus: what impact does data literacy have on your cash runway?
With data, you are always up-to-speed at the most granular level of the business. With the right foundation of Financial and SaaS metrics, you can slice and dice your financials to get a complete view of the company.
As a final note, capital efficiency metrics can help measure the return on spending for a path to long-term sustainability.
