When it comes to assessing the value of companies, one important factor is the runway involved. It’s the lifeline of startups (and of personal finances). Startups often have this idea that after they receive their newest round of funding that they can liberally make purchases on software, marketing, and headcount in a manner they weren’t able to before. But this is flawed and dangerous thinking.
From working with many startups, the ones that were cost-conscious since Seed stage all the way until their latest round of fundraising, were the ones who always had a healthy enough runway. They were never cash-strapped and were able to make fundamental business decisions that would improve the business’s bottom line, rather than spending for the sake of spending. It is those who treat those funds like their own money, that can weather any storm.
Runway is a measure for the health of a company — public or private, and this can be done through Altman’s Z-Score. This score calculates the probability that a company will file for bankruptcy within the next 2 years using five important variables, factored into a single linear combination.
Where the coefficients are tuned to the particular situation and the variables are as follows:
According to Altman, the Z-Score was found to be approximately 80% - 90% accurate in predicting a company’s bankruptcy one year before the event, with a Type II error (false positive) of approximately 15% - 20%. If you’re working at a startup, plug your numbers in and see how well the company is doing. Or, feed this data into an ETL and generate a live Z-score and treat it as a key metric.