Tim Brady - How do you calculate burn rate, runway and growth rate?

[Music] So how do you calculate burn rate, runway, and growth rate? Let me first start by saying that these are three very important metrics that are critical for you to manage your early stage startup. Every investor that you talk to will ask you for them, so you should know them off the top of your head.

Let's start with burn rate. As the name would suggest, it measures the amount of cash you're burning on a monthly basis. You calculate it pretty simply by taking all the cash that's going out in a month and adding back the amount of cash coming in. Notice I said cash, not expenses or revenue. Burn rate is a measurement of cash flow, not profit and loss, even though they're related. If a customer agrees to use and buy your product but they don't pay you until next year, that doesn't help your burn rate.

That takes us to runway. So, runway is the measurement of the number of months you have left before you run out of cash. The metaphor is obvious: how long do you have to get the plane off the ground before you crash and burn? Calculating the runway is pretty simple. You take the amount of cash that you have in hand or in your bank account and then you divide it by your burn rate.

Let me give you a simple example: let's say you have two hundred dollars in your bank account and your burn rate is ten dollars. Well, then you would say your runway is 20 months—20 months before you run out of cash. Running out of cash is usually how startups die, so this is useful information. It'll help you to prioritize things better and act accordingly.

Now, if the cash coming in the door is growing or your expenses are fluctuating, well then calculating runway gets a little more complicated. For these scenarios, you're going to need to make a monthly financial forecast. For each month, you're going to have to estimate the cash going out and the cash coming in, and that should help you calculate the number of months of cash that you have left. As a startup founder, you should be looking at these metrics on a weekly basis.

Now, let's talk about growth rate. Growth rate's another metric that investors will ask you about, and you should know off the top of your head. Unlike burn rate and runway, growth rate is not a measurement of cash, but rather a measurement of how fast your sales are growing. It's a pretty good indicator as to whether or not you've built something that people want, and investors will be intensely interested in it.

It's pretty easy to calculate. You can do it real quickly by taking this month's revenue and dividing it by last month's revenue, subtracting one, and then expressing it as a percentage. Let me give you a real quick example: if this month's revenue is 150 dollars and last month's revenue is 100, well then you would say your growth rate is 50.

It's important to know that this growth rate should be expressed as a compound number. What that means is as your sales grow, as your revenue grows, the denominator of that calculation grows as well. Sometimes you’ll see the acronym CMGR, Compounded Monthly Growth Rate—this is what you want. If you have any questions about how to calculate that over a longer period of time, there are plenty of resources online that can help you do that.

Now, one common mistake that we see founders make is they don't compound that growth. Let me give you an example of that mistake: let's say your revenues in January were a hundred dollars, and then six months later in July they were six hundred dollars. Now, some founders make the mistake of saying, "Well, my revenues grew 6x over six months, so my growth rate is a hundred percent." That's not correct. Your compounded monthly growth rate in that example is closer to 35 percent.

If you make that mistake in front of an investor, they'll think one of two things: either you're unsophisticated, or you're trying to sneak a fast one past them, neither of which is good. So don't make that mistake. Also, some businesses are seasonal, and they just don't lend themselves to a monthly growth rate. That's okay; it's okay to use a quarterly or an annual growth rate when talking to investors. Just make sure you're extra clear, both with yourself and especially with the investors, about what it is and how it's calculated.

If an investor thinks that you're trying to overstate your growth, the chances of them investing in you are pretty small. Lastly, there are two classifications of revenue in venture investing: there is recurring revenue and non-recurring revenue.

Let's say you run a monthly subscription product, and people pay you every month— that would be considered recurring, whereas a default someone just keeps paying you. In the venture world, recurring revenue tends to be valued more highly than non-recurring, for obvious reasons. As a default, people keep paying you, and hence your revenue streams are more predictable.

Now, if you're an e-commerce provider and you sell unique widgets, those are one-off purchases. Those aren't recurring; those are non-recurring revenue. Sometimes you will see the acronym MRR or Monthly Recurring Revenue. If your revenue is recurring, you can use that acronym. If it's not, don't. If an investor thinks that you're trying to sneak a fast one past them by saying that your revenue is recurring when in fact it's not, again, the chances of them investing in you become pretty small.

So don't make that mistake. Good luck building your startup!