Are you keeping track of your startup’s financial metrics? For any growing cannabis startup, being able to calculate runway accurately and reduce burn rate are critical components of success. Unfortunately, for most early-stage startup teams, it’s not unusual for them to quickly burn through cash without realizing the true extent of their spending. Before long, funds dry up and team members are left scratching their heads.
To help you avoid making the same costly mistakes, we’ve outlined a few simple strategies to help you better calculate startup runway, reduce burn rate to scale your cannabis startup.
How to calculate your startup burn rate:
Calculating startup burn rate is actually pretty simple. Burn rate is the actual amount of cash your account has decreased by in one month. Most of the time, it describes a company’s negative cash flow. It doesn’t include outstanding obligations, money that was transferred into another account, or money that’s on its way.
Some people make a distinction between two types of burn rate: gross burn rate and net burn rate. We think this complicates things unnecessarily. Here’s why:
Gross burn rate is the amount of cash that you spent in a single month. It does not take total revenue (incoming cash) into account.
Net burn rate takes the incoming revenue from cash into account. So net burn rate is your cash lost in a single month. In other words, you subtract revenue from spending and use that number to calculate your net burn rate. Net burn rate helps you understand how much more revenue you’d need to break even and how much longer you have until you run out of money if nothing changes.
To simplify things, we just refer to net burn rate as burn rate. There are two ways to calculate your burn rate: with and without venture capital (VC) or other investor funding.
Including Investor Funding
The easiest place to find the information you need is in a cash flow statement (also called a statement of cash flows). If you want to know your burn rate while including VC funding, then you don’t need to make any adjustments to the numbers you see.
To find burn rate for a given month, subtract the cash balance for the month from the cash balance in the previous month.
Burn Rate = Cash balance in prior month – Cash balance in current month
Simply put, burn rate is the net cash you are spending every month.
What Does It Mean if Your Burn Rate Is Negative or Zero?
Normally, the calculation above results in a number equal to or above zero. But there are a few situations in which your burn rate may come back as negative. That means that you’re earning more money than you’re spending. Say you just scored a round of funding — your burn rate might show as negative for that month because you appear to be gaining money overall.
If you haven’t added any investor funding, it could indicate that your revenues are finally greater than your expenses. If your burn rate is zero, it indicates that you’re earning and spending an equal amount of money. But once your startup is earning more than its spending, burn rate is meaningless. As a metric, it’s only helpful for startups that still have higher expenses than revenue.
Excluding Investor Funding
Many startup founders want to know their burn rate regardless of ongoing funding. It’s the same calculation, but you should first subtract any recent funding from your total cash, when relevant.
Burn Rate = (Cash balance in prior month – VC funding) – (Cash balance in current month – VC funding)
This is helpful if you want to know how close you are to recouping expenses just from revenue-generating activities. It’s also the first step in knowing how long your business would last if you stopped fundraising.
Calculating Average Burn Rate
If you’d like your average burn rate, repeat the process above for as many months as desired. Add the monthly burn rates together and divide by the number of months included. For example, to get your three-month average burn rate, you would add the burn rates together and divide by three. The calculator above will give you your average burn rate in addition to your company’s burn rate for each month included.
How to Reduce Burn Rate
The first step to stifle expenditure and reduce burn rate is to set very clear goals for every team member. Additionally, team members should follow the expense approval guidelines. This is critical because all team members should know the top priorities of the company, and focus all of their efforts on achieving those goals. If the startup is sophisticated enough, its accounting tool could build in rules to auto-enforce expenditure guidelines. These practices will encourage teams to cut down on unnecessary spending.
Additionally, growing startups should avoid:
Hiring Staff Prematurely: Before making any hiring decisions, it’s important to assess your startup’s needs accurately. Do you have a fully fleshed Minimal Viable Product (MVP)? Are you getting in front of enough prospects to determine demand with precision? What expertise do you need right now to get to the next step in your overall growth plan?
Securing Funding Before Clients: Before seeking venture capital investment, learn more about your customers’ preferences through product prototyping, informal focus groups, and surveys. Use these findings to create a hyper-targeted product that addresses customers’ wants and needs.
Forming Bad Partnerships: Startups should find corporate partners that understand the startup’s long-term vision. Has the corporate partner already accomplished something in the same sector? Does the startup have something to gain by joining forces?
Choosing the Wrong Work Environment: The best way to keep costs down is to seek shared office space. There, entrepreneurs can access flexible lease agreements and supportive communities conducive to entrepreneurial growth.
How to Calculate Runway
For this calculation, it’s more accurate to use your average burn rate (which you can obtain from the calculator above or by hand). Taking that average burn rate, divide the amount of money you have now by your burn rate.
Runway = Total cash held ⁄ Average burn rate = # months before you run out of money
The resulting number is how many months you have left before you run out of money (assuming expenses and revenue are constant and that you don’t add additional VC funding).
If you’d like to see a graph of your runway, the calculator above will generate that for you.
An Example Startup Runway Calculation
Let’s say your current cash holdings are $150,000 and last month’s cash holdings were $200,000.
Burn Rate = $200,000 – $150,000 = $50,000
Since you currently have $150,000, we can use that information to calculate your runway:
Burn Rate = $150,000 / $50,000 = 3 months
In this example, your startup has only 3 months of cash before running out of money.
Besides getting an accurate picture of your company’s financial health, knowing your burn rate and runway is an important step in securing funding. Some venture capitalists believe your company’s burn rate is a key metric for decision-making, especially if you haven’t launched a product yet.
These are numbers you’ll want to have ready if investors inquire (and they will). If you’re not planning to pursue funding again, then it’s part of a larger analysis demonstrating how much revenue you need — and when you need it by.
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