Hello, and welcome to this new blog!
Salient Point helps young companies make sense of the complex world around them. This can include customers, markets, suppliers, competitors, business models and investors. This blog is intended to share thoughts from my colleagues and I that might be of interest to our customers, and to others involved in technology startup businesses in Scotland and elsewhere.
I’ve had a few interesting conversations recently about the difference between the numbers that are useful in managing businesses, and the numbers that are usually used by accountants. I am very familiar with this from working in a larger consultancy earlier in my career, where none of the key numbers (forward load, utilisation and average fee rate) would ever appear in any formal financial statement.
These days I do most of my work with startups, which are often funded by investors and don’t have any sales to speak of. Until startups companies generate significant sales, the numbers I always want to see to manage the business are burn rate, runway and “drop dead” date. Since these don’t have formal definitions in conventional accounting, I thought I’d post the definitions I use! If you are using different numbers for the same purpose, perhaps you could post a comment and share your version with us!
Burn rate represents the costs incurred in the business each month.
In accounting terms, this is everything from the cost side of the P&L (Profit and Loss) account added together. It is based on the P&L figures rather than cash transactions to ensure it reflects activity, rather than the fact that the company just paid a pile of (overdue) invoices.
Tracking changes in this number over time helps understand whether costs are under control, and any significant variation from month to month should generally be explained. Where the figures do vary significantly, I have seen numbers presented as “underlying burn rate” , “exceptional items” and “total burn” to separate out exceptional expenditure.
The term “Runway” comes from the idea that an aeroplane has only a certain amount of runway available before it must take off. If by the end of the runway the plane is unable to take off, bad things tend to happen.
For most technology startups, the cash available (runway) must last long enough for the startup to generate significant sales or raise more investment (take off) or bad things will happen to the company.
The length of the runway (in months) is calculated by dividing available funds by the monthly burn rate projections. This gives an indication of when the company needs to make significant sales or raise external investment assuming current plans are followed.
Available funds are funds already in the company (retained earnings, investors money, grants etc) and funds that we know we will receive (grants already committed, VAT refunds, R&D tax credits). Available funds do not include potential sales, or any known outgoings such as tax bills.
Sometimes available funds are assumed to include e.g. a SMART award that is expected but not certain. In this case, it would be more accurately described as “runway assuming we win SMART”.
Burn rate projections will take account of additional spend, such as planned recruitment or fees for attendance at trade shows.
Drop Dead Date
Drop dead date is similar to runway but assumes that only cash already in the bank (less known outgoings such as tax bills) is available, and that burn rate continues at the current level. This tells us how long we can hold on without making cuts if things are not looking promising enough for planned growth to go ahead. The drop dead date would normally correspond to the point at which directors would have decide to cease trading if no cuts are made.
Obviously it is important to understand how numbers are calculated before using them, but I think the above definitions are a reasonable starting point for understanding these numbers in all the organisations I have worked with. Unless you know different?