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Here's Why Global Petroleum (ASX:GBP) Must Use Its Cash Wisely

Simply Wall St

Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

Given this risk, we thought we'd take a look at whether Global Petroleum (ASX:GBP) shareholders should be worried about its cash burn. In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

Check out our latest analysis for Global Petroleum

Does Global Petroleum Have A Long Cash Runway?

You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. When Global Petroleum last reported its balance sheet in December 2019, it had zero debt and cash worth US$1.8m. In the last year, its cash burn was US$2.0m. So it had a cash runway of approximately 10 months from December 2019. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. You can see how its cash balance has changed over time in the image below.

ASX:GBP Historical Debt April 6th 2020

How Is Global Petroleum's Cash Burn Changing Over Time?

Because Global Petroleum isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. As it happens, the company's cash burn reduced by 11% over the last year, which suggests that management may be mindful of the risks of their depleting cash reserves. Admittedly, we're a bit cautious of Global Petroleum due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Hard Would It Be For Global Petroleum To Raise More Cash For Growth?

While Global Petroleum is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future growth. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.

Global Petroleum's cash burn of US$2.0m is about 138% of its US$1.5m market capitalisation. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.

How Risky Is Global Petroleum's Cash Burn Situation?

Even though its cash burn relative to its market cap makes us a little nervous, we are compelled to mention that we thought Global Petroleum's cash burn reduction was relatively promising. After looking at that range of measures, we think shareholders should be extremely attentive to how the company is using its cash, as the cash burn makes us uncomfortable. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for Global Petroleum (3 are a bit concerning!) that you should be aware of before investing here.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.