Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given this risk, we thought we'd take a look at whether Aruma Resources (ASX:AAJ) shareholders should be worried about its cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
How Long Is Aruma Resources's Cash Runway?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. As at June 2019, Aruma Resources had cash of AU$664k and no debt. In the last year, its cash burn was AU$1.1m. That means it had a cash runway of around 7 months as of June 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. The image below shows how its cash balance has been changing over the last few years.
How Is Aruma Resources's Cash Burn Changing Over Time?
Whilst it's great to see that Aruma Resources has already begun generating revenue from operations, last year it only produced AU$504k, so we don't think it is generating significant revenue, at this point. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. As it happens, the company's cash burn reduced by 37% over the last year, which suggests that management are mindful of the possibility of running out of cash. Aruma 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 Easily Can Aruma Resources Raise Cash?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Aruma Resources to raise more cash in the future. 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. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).
Aruma Resources has a market capitalisation of AU$3.3m and burnt through AU$1.1m last year, which is 34% of the company's market value. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.
So, Should We Worry About Aruma Resources's Cash Burn?
Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Aruma Resources'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. 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 Aruma 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)
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.