Crijn Bouman, founder of Epyon Power, told me once:
We found out that the cash was running out too fast and as a typical technology startup, it takes a little longer to develop the product than anticipated, it takes a little bit more money than anticipated, the market is a little later.
Certainly, this is a very common situation, when you’re attempting to develop innovative products and services.
As a founder, you must pay special attention to the cash your startup has available now and in the near future. Once it’s a limited resource, it will be consumed while you are not able to generate enough revenue to offset the overall costs. And without money, your startup is over.
So, to be prepared for such challenge, I strongly recommend you to understand and keep in mind these 3 financial indicators: Cash Available, Cash Burn Rate and Cash Runway.
1. CASH AVAILABLE
It is the answer to the question: “how much is available now to be spent in my startup activities for the next months/years?”
Here, you may consider all the cash that is in your “hands”. It may be your own savings, borrowed money, raised funds, etc. But, remember: don’t consider anything related to possibilities nor promises (you may have a surprise about an investor or a friend changing his/her mind at the last minute).
2. CASH BURN RATE
It is the average amount of money monthly consumed from your cash available, to pay for your startup activities.
We may divide these costs into two different categories:
- FIXED COSTS: related to what you must pay in order to just keep your startup “running”. E.g., energy, water, rent, fixed services, property taxes, interest expenses (if you have debts), salaries, etc.
- BUSINESS DEVELOPMENT COSTS: these are the costs you’ll have to pay to develop your product, business model and marketing channels. E.g., prototypes, MVPs, advertisement tests, visits to prospects, paid researches, travels, interviews, calls, specific services, etc.
For instance, if you estimate your startup will spend $24,000 in the next 12 months, your Cash Burn Rate will be $2,000/per month (i.e., total costs divided by number of months).
3. CASH RUNWAY
This last indicator is based on the previous two. It is related to the question: “how long can my startup survive with its current funds, considering its cash burn rate”.
So, considering the cash burn rate of $2,000/month, if you had only $12,000 in cash available, your startup cash runway would be 6 months (i.e., cash available divided by cash burn rate).
In other words, you would have only 6 months to make your startup generate net revenues equal or higher than your cash burn rate ($2,000/month). Otherwise, it would run out of cash in the beginning of the seventh month.
GETTING THE NUMBERS
To do all this calculation, you may use Microsoft Excel, Google Spreadsheets or similar services/softwares.
If you prefer, you may download for FREE our “3 Financial Indicators” spreadsheet:
Subscribe to get the “3 Financial Indicators” spreadsheet for Free
Now, after replacing the numbers on the yellow cells of the spreadsheet by your startup numbers, you should be able to state your CASH AVAILABLE, CASH BURN RATE and CASH RUNWAY.
USING THE NUMBERS TO BASE YOUR DECISIONS
Of course, just knowing these 3 numbers won’t save your life. You have to be able to take some action on them too. As a founder, one of your key responsibilities is to keep your startup alive long enough until its revenues are sufficient to sustain the business. It means, you must find ways to extend your cash runway.
You may accomplish that by:
- Raising more funds: if the cash is being consumed, you may bring new cash to the startup. In that case, you may put more of your own money in the company or search for new investors, for example.
- Reducing Cash Burn Rate: Instead of trying to raise the amount of available cash, an alternative would be to think about which costs are really needed and which are not or may be reduced. This should be a frequent analysis strongly based on concepts from Lean Startup Methodology as: failing cheap and minimum viable product.
Obviously, cash management activities in a pre-traction startup are not easy, once there is no money going in. But, be sure: this understanding will be vital to take your startup to the traction stage.
Please, let me know your opinion about this post, spreadsheet or both! 🙂