Cash is the fuel that keeps a business running; if your startup runs out of cash, it will sputter awhile and then conk out.
You can have a great product, a solid customer base, and all the right metrics — yet still run out of money if you don’t manage it well.
There’s no getting around it: Startups have to spend money to make money.
SaaS startups, specifically, have to increase cash flow in order to scale. That can be challenging for founders who are often just learning about managing cash burn — that is, strategically controlling the rate at which they spend the money they have.
It’s more about achieving balance than minimizing spending.
You don’t want to run so lean that you miss growth opportunities to lose out to aggressive competitors. Of course, reckless spending isn’t sustainable either, and doing so would make it harder — or at least costlier — to secure capital to fund your runway later.
At times you’ll hit the accelerator and spend money to make big strategic moves quickly. Other times, you’ll want to tap the brakes to slow down so you don’t burn through precious capital.
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Calculating and managing your startup’s cash burn rate are fundamental to growing a healthy SaaS business, regardless of whether you want to keep expanding or secure a successful exit. Below, we’ll show you how to calculate your startup’s burn rate and give you tips for reducing your cash burn so your burgeoning business can thrive.
Calculate Your Burn Rate
Your cash burn rate shows how quickly your business is spending the cash it has in the bank (your current cash balance). It helps you understand how long your cash will last — in other words, how much runway you have.
Burn rate is not a one-time calculation, because cash flow fluctuates from month to month. All startups have to monitor their cash burn closely, adjusting as needed to continue operations. It’s even more crucial to know your burn rate before making big business decisions, like expanding staff, or when you are fundraising.
Cash burn rate formulas:
Gross burn = Monthly cash expenses
Net burn = Monthly cash expenses (gross burn) – monthly revenue
Gross burn does not take into account incoming cash or revenue. This calculation will tell you how long your business can survive on the cash you have, given your current expenses.
For growing SaaS startups with recurring revenue, net burn is a much more useful calculation. Net burn will give you a realistic view of your cash runway, accounting for both incoming cash and expenses.
To calculate your runway, simply divide your current cash by your burn rate:
Runway (in months) = Current cash balance ÷ Net burn
Example
Your startup has $1 million in the bank. Looking at the last 3 months, your total expenses were $450,000 and your total revenue was $150,000.
Net Burn = $450,000 - $150,000 = $300,000 ÷ 3 months = $100,000/month
Runway = $1,000,000 ÷ $100,000 = 10 months
Alternative methods for calculating burn rate and runway
1. Use EBITDA from your P&L as a proxy for net burn, and pull your current cash from your balance sheet:
Runway = Current cash balance ÷ EBITDA
2. Use Net income/Net loss from your P&L as a proxy for net burn:
Runway = Current cash balance ÷ Net loss
What is a good burn rate for a SaaS startup?
SaaS startup burn rates will differ with lifecycle stages. Your burn rate when you’re in the MVP-building stage, for example, will probably be more conservative than in your post-release growth stage, when you’re in a mad dash to acquire new customers.
In general, a healthy SaaS startup should aim for a burn rate that affords you at least 12 months of runway.
Using our formula, you can plug in your current cash to see where your monthly cash burn should be to have a 12-month runway, which will help you make smarter near-term business decisions.
Example
12 months = $1,000,000 ÷ Net burn
$1,000,000 ÷ 12 months = Net burn
$83,333/month = Net burn
Using our earlier example, we’re burning $100,000 a month — $16,667 more than we should be to have a 12-month runway — so it’s essential we cut costs to reduce our burn rate.
If you’re in this position, here are some effective strategies:
4 Ways to Reduce Startup Burn Rates
Cutting costs is the first move most founders make to control their cash burn, but that’s not the only way to manage cash. Consider all four of these strategies for reducing burn rate:
1. Reduce expenses
Trimming headcount and slashing budgets are likely to curtail your revenue and growth, not to mention hurt morale. These options can help reduce burn without hurting momentum:
Go virtual. By becoming a fully remote company, you’ll save big on office space and other physical assets, and you’ll find talent for less because you can hire people from virtually anywhere.
Quiet down the megaphone. Switch your focus to lower-cost marketing channels that have long-term benefits, and temporarily suspend paid advertising.
Pare costly outlays. Evaluate your software subscriptions, and find opportunities to cut licenses, switch to cheaper solutions, test something new with a free trial, and take advantage of discounts.
2. Increase incoming revenue
Acquiring new customers is a solid path to more revenue, but it could take a while to see that cash if your pipeline is slim and your sales cycles are long. These tactics can boost your revenue:
Upsell your best customers with service add-ons that create value, or secure commitments for longer-term contracts early.
Tout your expertise. Have a great, meaty piece of content or a killer presentation? Turn it into a self-published book and sell it online, or create an online course that people will want to pay for. You’ll generate passive income and elevate your brand profile.
Evaluate your pricing strategy, and see whether you should be charging more, or consider a multi-tiered pricing model to broaden your customer base and scale your revenues long term.
3. Look for capital before your need it
Whether you bootstrap or choose to work with VCs, most SaaS startups will need growth capital to scale at some point. If you need additional runway or growth capital, don’t wait until the last minute.
A healthy startup that’s managing its cash burn and has at least 12 months of runway will get optimum terms for growth capital from lenders and investors.
Always have a plan for your best- and worst-case scenarios, whether that’s having a line of credit in case of an emergency or securing financing so you can start your next fiscal year with two to three years of runway.
4. Think like a CFO
It’s time to get comfortable managing cash flow and budget, so cozy up to your accounting tools and sharpen your financial acumen. When you’re ready to grow quickly and you have that long runway in place, there’s one more important cash flow concept many tech startup leaders miss: There’s almost always a lag in ROI when deploying new capital.
Three essential tips:
Deploying new capital will increase your expenses; understand that your top-line revenue will probably take time to catch up.
Pay close attention to the term length and payment terms if you’re considering debt financing. Payments on some short-term loans can easily burn up your free cash flow and put you in a financial pinch before you start seeing revenue increase from that capital investment.
Set realistic time frames. Consider how long it takes to find and onboard a key new hire, as well as to benefit from their contributions. Likewise, a product launch can require multiple iterations, and market adoption also takes time.
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