Doomsday Ratio
The “Doomsday Ratio,” sometimes also known as the “Cash Burn Ratio,” is a financial metric that is used to assess the financial sustainability of a company, especially those in early stages like startups. It indicates the amount of time (usually in months) a company can continue to operate using its available cash reserves without additional financing or revenues.
The ratio is calculated by dividing the company’s current cash balance by its monthly cash burn rate. The cash burn rate is the rate at which a company is spending its capital to finance its overheads before generating positive cash flow from operations. It is usually calculated over specific periods such as a month, quarter, or year.
For example, if a startup company has $500,000 in cash and is spending $100,000 per month (its burn rate), its Doomsday Ratio would be 5. This means that, assuming its burn rate remains constant and it doesn’t bring in any additional revenue or investment, the company has enough cash to continue operating for 5 more months.
While this ratio can be a useful measure of a company’s financial sustainability, it’s also a somewhat simplistic measure, as it assumes that the company’s burn rate will remain constant and doesn’t take into account any future revenues or changes in expenses. As such, it’s just one of many metrics that investors and managers should look at when assessing a company’s financial health.
Example of the Doomsday Ratio
Startup A is a technology company that has recently raised $2 million in venture capital funding. The company is currently in its development phase and is not generating any revenue yet. The company’s current monthly operating expenses, or burn rate, amount to $200,000, which includes costs such as salaries, rent, utilities, and development costs.
The Doomsday Ratio can be calculated as follows:
\(\text{Doomsday Ratio} = \frac{\text{Cash Balance}}{\text{Monthly Burn Rate}} \)
For Startup A, this would be:
\(\text{Doomsday Ratio} = \frac{\$2,000,000}{\$200,00} = 10 \)
So, Startup A has a Doomsday Ratio of 10, meaning it has enough cash to survive for 10 months at its current burn rate, assuming no additional funding or revenue comes in during this period.
This ratio gives the company’s management and investors a sense of its financial sustainability and the urgency to either generate revenue or raise additional funding to continue its operations. However, this is a simplified measure and must be combined with other financial metrics and business insights to get a complete picture of the company’s financial health.
