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Here's Why We're Not At All Concerned With African Energy Resources's (ASX:AFR) Cash Burn Situation

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There's no doubt that money can be made by owning shares of unprofitable businesses. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So, the natural question for African Energy Resources (ASX:AFR) shareholders is whether they should be concerned by its rate of cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. 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 African Energy Resources

When Might African Energy Resources Run Out Of Money?

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. As at June 2019, African Energy Resources had cash of US$2.6m and no debt. Looking at the last year, the company burnt through US$533k. So it had a cash runway of about 4.8 years from June 2019. A runway of this length affords the company the time and space it needs to develop the business. The image below shows how its cash balance has been changing over the last few years.

ASX:AFR Historical Debt, January 19th 2020
ASX:AFR Historical Debt, January 19th 2020

How Is African Energy Resources's Cash Burn Changing Over Time?

Because African Energy Resources 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. While it hardly paints a picture of imminent growth, the fact that it has reduced its cash burn by 36% over the last year suggests some degree of prudence. African Energy Resources makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Hard Would It Be For African Energy Resources To Raise More Cash For Growth?

While African Energy Resources 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. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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.

African Energy Resources's cash burn of US$533k is about 3.6% of its US$15m market capitalisation. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.

Is African Energy Resources's Cash Burn A Worry?

As you can probably tell by now, we're not too worried about African Energy Resources's cash burn. For example, we think its cash runway suggests that the company is on a good path. And even though its cash burn reduction wasn't quite as impressive, it was still a positive. Looking at all the measures in this article, together, we're not worried about its rate of cash burn, which seems to be under control. We think it's very important to consider the cash burn for loss making companies, but other considerations such as the amount the CEO is paid can also enhance your understanding of the business. You can click here to see what African Energy Resources's CEO gets paid each year.

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.