How do you calculate a startup's runway?

Runway is calculated by dividing the total cash a startup has on hand by its monthly burn rate. This shows how many months are left before the company runs out of cash.

What is the formula for calculating growth rate?

Growth rate is calculated by taking this month's revenue, dividing it by last month's revenue, subtracting one, and then expressing it as a percentage. It indicates how fast sales are growing.

What is compounded monthly growth rate (CMGR)?

CMGR is the desired growth rate metric, accounting for compounding. As sales grow, the denominator in the calculation also grows, providing a more accurate picture of sustained growth.

When should a startup use quarterly or annual growth rates instead of monthly?

If a business is seasonal, it's acceptable to use quarterly or annual growth rates when communicating with investors. Clarity on the calculation method is crucial.

What is the difference between recurring and non-recurring revenue?

Recurring revenue comes from ongoing payments, like monthly subscriptions, making revenue streams predictable. Non-recurring revenue comes from one-off purchases, such as individual product sales.

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Tim Brady - How do you calculate burn rate, runway and growth rate?

Y Combinator

Science & Technology5 min read6 min video

Jan 25, 2021|22,110 views|568|33

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TL;DR

Startups can avoid crashing by knowing their burn rate and runway, but mistaking simple growth for compounded growth can kill investor trust.

Key Insights

Burn rate measures monthly cash outflow, not accounting expenses, and investors require founders to know it offhand.

Runway is calculated by dividing current cash by the monthly burn rate, providing a critical 'months left' metric.

Compounded monthly growth rate (CMGR) is the correct way to express growth, and falsely claiming simple 6x growth as 100% is a major investor red flag.

If cash flow is irregular, founders must create a monthly financial forecast to accurately estimate runway.

Recurring revenue is valued more highly by venture capitalists than non-recurring revenue due to its predictability.

Burn rate: tracking actual cash outflow

Burn rate is a critical metric for early-stage startups, representing the net cash leaving the company on a monthly basis. It's calculated by taking all cash outflow and adding back any cash inflow. Crucially, burn rate measures cash flow, not accounting profit or loss. This means that even if a customer agrees to a purchase, if payment isn't received within the month, it doesn't offset the burn rate. For example, if a customer buys a product in January but pays in February, the January cash outflow is still counted as part of the burn. Even though they are related, understanding the difference between cash flow and profit and loss is essential for accurate burn rate calculation. This metric is fundamental because it directly impacts a startup's survival time and is a key figure investors will always inquire about. Founders should have this number readily available at all times.

Runway: predicting survival time

Runway is a direct extension of burn rate, indicating the number of months a startup has before it depletes its available cash. The calculation is straightforward: divide the total cash currently in the bank by the monthly burn rate. For instance, if a startup has $200 in their account and a burn rate of $10 per month, their runway is 20 months. This metric is vital for survival, acting as a stark warning of how long the company can operate before running out of funds, a common cause of startup failure. Knowing the runway helps founders prioritize activities, make informed decisions about spending, and plan fundraising efforts proactively. It's a tangible measure of time, essential for strategic planning and operational management to avoid an untimely crash.

Forecasting for irregular cash flow

When a startup's cash inflow or outflow fluctuates significantly, or when cash coming in is growing, calculating runway becomes more complex than a simple division. In such scenarios, founders must develop a detailed monthly financial forecast. This forecast involves estimating the cash that will leave the company and the cash that is expected to come in for each upcoming month. By projecting these figures, founders can compute a more accurate number of months of cash remaining. This proactive approach to financial planning is crucial for navigating volatile periods and ensuring the company has sufficient runway, even with unpredictable revenue streams or expenses. Regularly reviewing and updating these forecasts, ideally on a weekly basis by the founder, is paramount for maintaining a clear picture of the company's financial health and making timely adjustments.

Growth rate: measuring market traction

Growth rate, unlike burn rate and runway, is not a measure of cash but rather an indicator of how quickly a startup's sales are increasing. It serves as a strong signal that the company has developed a product or service that resonates with the market and that customers want. Investors pay close attention to growth rate because it reflects market traction and scaling potential. The basic calculation involves taking the current month's revenue, dividing it by the previous month's revenue, subtracting one, and then expressing the result as a percentage. For a simple example, if this month's revenue is $150 and last month's was $100, the growth rate is 50%. This metric is important for understanding the momentum of the business and its potential for expansion.

The importance of compounded monthly growth

It is crucial to understand growth rate as a compound number, often referred to as compounded monthly growth rate (CMGR). This means that as revenue grows, the denominator in the calculation also increases over time, reflecting a consistent growth trajectory. A common and damaging mistake founders make is calculating growth linearly. For instance, if revenue grows from $100 in January to $600 in July (a 6x increase over six months), claiming a 100% growth rate is incorrect. The actual CMGR in this scenario is closer to 35%. Presenting such a miscalculation to investors can lead them to believe the founder is either unsophisticated or intentionally trying to mislead them, both of which can severely damage credibility and kill investment opportunities. Therefore, accurately calculating and reporting CMGR is non-negotiable for building investor trust.

Adapting growth rate for seasonality

Not all businesses experience consistent, month-over-month growth. Some industries or products are inherently seasonal, making a monthly growth rate calculation less meaningful. In such cases, it's acceptable and often more appropriate to use quarterly or annual growth rates when discussing performance with investors. However, clarity is paramount. Founders must be explicit about the time period used for calculation, ensuring both themselves and investors fully understand the metric. Misrepresenting or ambiguously presenting growth figures, especially to suggest stronger performance than reality, can be detrimental. Investors are sophisticated and can easily detect attempts to obscure or overstate growth, significantly reducing the likelihood of securing investment.

Recurring vs. non-recurring revenue

In venture capital, revenue is broadly categorized into two types: recurring and non-recurring. Recurring revenue, such as from monthly subscriptions where customers consistently pay, is highly valued because it signifies predictable income streams. For example, a SaaS product with monthly billing generates recurring revenue. Non-recurring revenue, on the other hand, comes from one-off purchases, like selling individual widgets in e-commerce. Investors prefer recurring revenue due to its stability and predictability. Metrics like Monthly Recurring Revenue (MRR) are used for businesses with recurring models. Misrepresenting non-recurring revenue as recurring can be a significant red flag for investors, indicating a lack of understanding or an attempt to deceive, thus diminishing the chances of investment.

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Common Questions

Burn rate measures the cash a startup spends monthly. It's calculated by taking all cash going out in a month and adding back the cash coming in. It focuses on cash flow, not just expenses or revenue.