What is Burn?

Burning cash means that the company is still unprofitable and has negative cash flow. The burn refers to the money leaving the business.

Early-stage companies are almost expected to experience this for the first few years of business. It is rare to see a young company growing quickly and maintaining profitability. Large growth-stage companies and public companies commonly burn cash as well.

The burn is due to the level of investment that they are deploying into growth. Regardless of the company stage, monitoring cash is vital to a company's success.

There are two ways to calculate the burn rate using different financial statements:

Balance Sheet Calculation: (Cash at the end of the period - Cash at the beginning of the period)

The Balance Sheet approach subtracts the cash balance at the end of a period (e.g., month, quarter, year, etc.) from the cash balance at the beginning of the same period.

Income Statement Calculation: Monthly Earnings (aka Net profit/loss) Ignoring Depreciation and Amortization

The Income Statement approach is calculated using Earnings Before Depreciation and Amortization (EBDA). EBDA is calculated by finding the earnings (loss) and removing depreciation or amortization. The metric allows us to see all the cash burn in the business. While EBITDA may be a more widely-known metric, interest and taxes are still cash items and must be included in cash burn.

What is Runway?

Burn doesn't tell us much on its own. However, using the burn, we can understand how much gas we have in the tank before raising more capital or becoming cash flow positive. The best way to accomplish this is by calculating months of runway.

Months of Runway: Ending Cash Balance / (3 Month Average Cash Burn)

We can calculate our months of runway by dividing cash by our average monthly burn. The volatility of cash burn in some ventures can make it challenging to rely on this calculation. Therefore, using an average monthly cash burn based on the past three months is a better approach.

The cash burn and months of runway calculations help operators and investors understand the capital needs. For example, entrepreneurs typically like to raise 18-24 months of runway in a single financing round. Understanding your burn and runway allows operators to calculate the necessary round size.

We all know that we get a few more miles when the "empty" light comes on in our car. Your startup's "empty" light starts flashing at six months of cash. The best venture-backed management teams have a signed term sheet before dropping below six months of remaining runway. Raising plenty of months of runway left allows management time to evaluate deal terms and make the best situation thoughtfully. Mistakes are made, and poor deal terms are taken when your back is against the wall to accept any terms necessary.

Give yourself time, and always leave enough runway in the tank.