Burn rate, runway and cash conversion cycle explained in plain terms, plus the simple formula that tells you how much cash reserve your business needs.
Ask most owners how much cash their business needs to be safe and you will get a feeling, not a number. There are three numbers that replace the feeling, and they are connected.
Burn rate
Your burn rate is what you actually spend per month, fully loaded: payroll, contractors, rent, insurance, software, and the tax amounts you need to set aside. It is the starting point for everything else.
Runway
Runway is cash in the bank divided by your burn rate. It tells you how many months the business would last if no new money came in.
Cash conversion cycle
This is how long it takes to go from first contact with a lead to money cleared in your bank account. It is not invoice to payment. It is the full cycle, from the first conversation to cash you can spend.
How the three fit together
Put burn rate and the conversion cycle together and you get your minimum cash reserve:
Minimum cash reserve = burn rate x cash conversion cycle
If you spend $100,000 a month and it takes three months to turn a new job into cleared cash, you need at least $300,000 in reserve to operate normally while that cycle plays out. That number is the floor, not the target. Add any one-off expenses you can see coming, and a realistic reserve is closer to double the minimum.
Put differently, your runway should be at least as long as your cash conversion cycle.
What about the six months of expenses rule?
Plenty of owners tell me they hold six months of expenses in reserve. It is a reasonable instinct, and it uses the same building block: your burn rate. The difference is that six months is a number someone picked. Your conversion cycle is a number you can measure.
A business that collects upfront may be holding more than it needs. A contractor with progress billing, holdbacks and long project cycles may need more than six months and not know it. The formula shows you which one you are.
Your bank balance is not your available cash
One more adjustment. A chunk of what sits in your account is already spoken for: HST you have collected but not remitted, payroll source deductions, and tax instalments. The money is in the account, but it is not yours to spend.
Start with your burn rate this week. Then answer honestly: how long does it take, from first conversation to cleared cash? Multiply the two and compare the result to what is in the bank. What number did you get?