How to calculate cash runway

Cash runway, in months, is available cash divided by the average net cash outflow per month. Net outflow is the cash going out in a month less the cash coming in.

business.gov.au's cash flow statement template works out a monthly cash balance by taking total cash outgoing away from total cash incoming. When that monthly figure is negative, the business is drawing on its cash, and the size of the shortfall is the net outflow. The divisor must be above zero. A business whose cash is growing each month has no runway in this sense, though it still needs a forecast.

Burn rate is the speed at which a business uses up its cash, usually measured per month; cash runway is how long the cash on hand would last at that speed. One is a rate and the other is a length of time, and the runway is worked out from the burn.

Burn is used in two senses, so be clear which one a figure means:

• Gross burn is all the cash going out in a month, before anything coming in is counted. For the design business in the example further down, month 1's gross burn was 26,900.00.
• Net burn is the cash going out less the cash coming in. It is the net outflow the runway calculation divides by, and for the same month it was 8,500.00.

Runway uses net burn because the cash coming in pays for part of what goes out. Gross burn is still worth knowing: it is roughly what the business would need each month if sales stopped for a while, such as during a shutdown or after losing a large customer. Cash flow, in business.gov.au's glossary, is the money flowing in and out of a business. Net burn is simply the size of that flow's shortfall in the months when more goes out than comes in.

In business.gov.au's glossary, cash is all the money a business can access on demand: coins, notes, petty cash, some cheques and money held in savings and debit accounts. To get a reliable figure:

• reconcile each bank account to the same date and use the reconciled balances
• count petty cash and the till float
• leave out any unused overdraft or credit card limit, because that is borrowing you could draw on, not cash you hold
• leave out money that belongs to someone else, such as funds you are holding on a customer's behalf.

Use actual cash movements for several recent months, from the cash flow statement or the bank statements. Include every payment that uses cash, such as loan repayments, purchases of equipment and money the owners take out, even though some of these never appear in the profit and loss statement. Leave out one-off receipts that won't repeat, such as a loan being paid into the account, and note any unusual payment separately.

The result is in months, and it assumes the recent pattern carries on unchanged. Any change in sales, costs or the timing of large bills moves it, which is why the next step matters more than the number itself.

business.gov.au explains that a cash flow forecast estimates future sales and costs, so you can tell whether income will be enough to meet them, and that its cash flow statement template can hold the estimated figures. Each month starts from the previous month's closing balance, adds cash coming in and takes away cash going out.

The month in which the forecast closing balance would fall below zero is a sharper answer than any average. It picks up an annual insurance premium, a quiet season or a large supplier bill that a simple average spreads out. business.gov.au's cash flow guidance suggests that a business with predictable quiet spells builds up enough cash beforehand to carry it through.

An average treats every month as alike. When the net outflow is growing, the simple calculation gives a runway that is too long, and working month by month shows by how much.

A small furniture maker has 30,000.00 in the bank after reconciling. Its net outflow over the last three months was 2,500.00, 3,000.00 and 3,500.00, an average of 3,000.00, so the simple calculation gives 30,000.00 divided by 3,000.00, or 10 months. But the outflow has risen by 500.00 each month, and the owner expects that to continue for a while: a new product line is being set up, and timber is being bought well ahead of any sales.

1. Start from the reconciled cash: 30,000.00.
2. Estimate each month's net outflow from what you know is coming, not from the average. Here the owner carries the recent rise forward, adding 500.00 a month.
3. Take each month's net outflow from its opening cash to get the closing cash, and carry that closing figure into the next month.
4. Find the first month that closes below zero. Here it is month 6.

The average said 10 months; the month-by-month view shows the cash running out during month 6. Dividing by the latest month's outflow instead, 30,000.00 divided by 3,500.00, gives about 8.6 months: closer, but it still misses the rise still to come. A burn can change the other way too. If a large contract has just started paying, the average understates the runway. Whenever the recent months are not alike, work month by month rather than trusting a single average.

• Collecting from customers sooner, for example by invoicing promptly and following up overdue accounts.
• Holding less stock, so less cash is spent ahead of sales.
• Agreeing longer terms with suppliers. business.gov.au's example is negotiating a 60-day payment term in place of 30 days.
• Reducing costs the business can do without.
• New funding, which adds cash but usually brings repayments or other obligations of its own.

business.gov.au treats constantly needing more cash than you have as a sign of financial strain. If the runway is short, act early and speak with your accountant or a business adviser. For businesses in financial difficulty, business.gov.au also points to the Small Business Debt Helpline, a free financial counselling service.

No single number of months suits every business. A more useful question is whether the runway is longer than the time you would need to change course, and that depends on your own business rather than anyone else's. Measure it against:

• how long it is until the next large receipt you can count on, such as a contract payment or the start of your busy season
• how long your quiet season usually lasts, from your own records of earlier years
• how long a change would take to bring in cash: new prices help only once customers pay at them, and some costs can only be cut after a notice period
• which way the runway has been moving: one that shortens month after month needs attention even while the number still looks comfortable.

Line up each month's runway with the month before and the same month last year. A seasonal business can expect the figure to swing, so the comparison that matters is with the same point in its own cycle.

Check the figure first, then turn it into dates and a full list of what is owed each way, and talk to the people involved before a payment is missed. The steps are general, and most come from business.gov.au's guidance on managing debt:

1. Check the inputs. Reconcile the accounts, make sure the cash figure leaves out unused credit limits, and confirm no one-off receipt is flattering the average.
2. Build the month-by-month view, or a week-by-week one if cash is very tight, so you have a date rather than an average.
3. List what the business owes and what it is owed. business.gov.au's first step for a business managing debt is to assess both.
4. Chase money owed to you. Contacting late or non-paying customers is one of business.gov.au's steps, because what they pay helps cover the business's own debts.
5. Decide what to pay first. business.gov.au suggests working out what you can afford to pay now, what you can pay later and when a payment plan makes sense, with a budget to direct money where it matters most.
6. Talk to the businesses you owe early. business.gov.au suggests explaining your circumstances, asking whether they have hardship provisions, asking about a later due date, a part payment or a payment plan, and keeping a record of each conversation.
7. Talk to your bank and explain what you have done so far. business.gov.au suggests preparing a profit and loss statement or a cash flow forecast for that conversation.
8. Improve the position before looking for new money. business.gov.au's funding guidance says to try to improve the financial position before seeking funding to get through tough times.

The later steps either bring cash in sooner or push a payment later, and the runway changes only when the cash does. Recalculate after each change, keep notes of what was agreed with whom, and speak with your accountant early about your own situation.

• It looks backwards. Next quarter may not look like last quarter.
• It ignores money customers owe until it is actually collected.
• A growing business can burn more cash as it grows, because stock and unpaid invoices grow too.
• Recalculate it each month from reconciled figures, so a shortening runway shows up early.

A simple spreadsheet is enough to work out runway each month, and it doubles as a record of how the figure has moved. Keep three parts on one sheet:

• Cash available: one row for each bank account and for petty cash, each taken at the same reconciled date, less any money held for someone else.
• Net outflow: the cash in and cash out for each recent month, copied from the cash flow statement, with a row that averages the net figure and a note beside any one-off item you left out.
• Months ahead: one row per month, laid out like the furniture maker's table, with an opening figure, an estimated net outflow and a closing figure carried into the next month. A line chart of the closing cash shows at a glance where it would cross zero.

Save a copy each month rather than overwriting the last one, and keep it with the bank statements and reports the figures came from. Months later you can check how close the estimates were and see whether the runway has been lengthening or shortening.