Cash Is Not Profit

One definition of finance I like: Finance = Accounting + Time. Another: finance is the art of making decisions under uncertainty.

In Accounting 101 we banged the drum that Cash Is Not Profit. Here are just a few ways a profitable company can go bankrupt:

1. You win a big contract, but you don't get paid until well after you've spent heavily ramping up inventory or staff.
2. You can't make large loan payments.
3. You had to lay people off in a downturn, and now you aren't making nearly enough to keep things going at the level you need.

Too many founders don't seriously forecast their cash. They don't know how, don't want to look at their bills, or don't think they can predict the future. Even the Psychic Friends Network said in its press release that it declared bankruptcy "due to unforeseen circumstances." Revenue is hard to predict. Expenses are usually much easier: your vendors kindly tell you what you owe, and many expenses are the same every month.

Until cash stops being a worry, the two things every founder must always know are Burn Rate and Runway.

Burn Rate

Burn Rate is how much cash you go through, on average, per month. I work from the Cash Flow Statement, not the P&L, because once again, Cash is not Profit!

The simplest way: subtract the End of Period cash from the Beginning of Period cash. Start the month with $450,000, end with $400,000, and you burned $50,000. One adjustment: I leave out any investment received. If you got $25,000 from a SAFE this month, it doesn't count against your burn. Loan payments do count.

Then Burn Rate is the average monthly burn over a stretch of months. There's no set rule for how far back to go. Pick the period where your situation has been basically the same, and say why in your assumptions.

Picking the Right Period

Here's a company that last October had only $125,000 in cash and spent about $30,000 a month on operations. Then it raised $2,500,000 in a SAFE, and operations jumped to $210,000 in November, which is typical right after a raise. So burn measured from October mixes two different companies.

From November, operations held steady through January. But in February they jumped by about $100,000 a month, likely new hires. If we expect that higher spending to continue, February forward is the right period:

So with my management team and in reports to investors, I'd say our Burn Rate is $294,000 a month, going back to February.

Runway

Runway is how many months you can go at your current Burn Rate before you run out of cash.

Runway = Current Cash ÷ Burn Rate = $1,144,500 ÷ $294,167 = 3.9 months

Always round Runway down, so this is three months. At the start of May, that means cash runs out sometime in July. Don't wait until July to act: more investment usually takes months and months, and a three-month runway is not a good place to be.

EZ Numbers shows everything! You don't have to rely on an average: your plan shows exactly when you would or wouldn't run out of cash, month by month. It's fine not to be profitable for a year, several years, or even the whole projection. But you can't run out of cash. If your plan shows cash going below zero, change something in the plan to fix it.