Last week I was introduced to a new term when someone asked me, ‘what’s my company’s runway?’ And as this someone wasn’t running an aviation company, I was momentarily baffled.
Turns out, it’s a term used in the tech start-up circles. (We can add it to the list of metaphors this sector has had to adopt to help describe its concepts: disruption, agile, incubator and so on).
According to http://startupdefinition.com/runway it’s “the amount of time until your startup goes out of business, assuming your current income and expenses stay constant. Typically calculated by dividing the current cash position by the current monthly burn rate.”
(There’s another metaphor for you: 'burn rate'. It just means your net monthly loss.)
This concept makes sense for start-up businesses, where you have a finite amount of cash to spend on your business before it runs out, rather like a plane running out of runway. Unless the business can generate its own revenue before that time, it will crash and burn (this metaphor has really… oh, don’t make me say it… taken off.)
Turns out that runway is just a fancy name for a calculation many accountants and financial analysts would use quite regularly. It’s of use not just to start ups, but to existing businesses too – although for existing businesses which already generate their own revenue, it’s less a predictor of when they will run out of money, and more an indication of how long they could operate using their cash alone.
To give it a more descriptive title, let’s call it “cash assets in months”. You can calculate it yourself using this formula:
(Cash + accounts receivable) divided by average monthly expenditure.
The cash and accounts receivable figures are on your balance sheet, which you can produce through your accounting software.
Average monthly expenditure is your annual expenses (from your profit and loss statement, also easily generate through your accounting software) divided by 12.
And presto, you have the length of your runway in months.
This is an example of financial ratio analysis (oh, that’ll never catch on. Someone give it a funky tech start-up style title please), which is a way of gaining insight into your company’s financial position using a series of simple formulas. Online services such as Fathom use ratio analysis to produce a range of reports which can help guide your business decision making.
Related blog posts:
- Do you really need to write a business plan?
- Is my startup burning through cash too quickly?
- Are you happy with your 5-year business plan?
But the trick is to know which ratios are genuinely useful for your company. It’s likely you only need to track a handful of key ratios over time, rather than sifting through dozens of them, getting lost in the process. They are best used sparingly and with care.
Here at Generate, we undertake this kind of ratio analysis regularly for a range of private companies and for large government organisations. If you’d like to chat about how you can use these metrics to assess your own company’s position, please get in touch. We’ll sort through all the jargon (air travel related and otherwise) to find something that works for you.