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, Sovereign Metals (ASX:SVM) shareholders have done very well over the last year, with the share price soaring by 388%. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

In light of its strong share price run, we think now is a good time to investigate how risky Sovereign Metals' cash burn is. 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

View our latest analysis for Sovereign Metals

When Might Sovereign Metals Run Out Of Money?

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. In December 2020, Sovereign Metals had AU$2.3m in cash, and was debt-free. In the last year, its cash burn was AU$3.4m. Therefore, from December 2020 it had roughly 8 months of cash runway. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. The image below shows how its cash balance has been changing over the last few years. debt-equity-history-analysis

How Is Sovereign Metals' Cash Burn Changing Over Time?

Although Sovereign Metals reported revenue of AU$38k last year, it didn't actually have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. Given the length of the cash runway, we'd interpret the 26% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Sovereign Metals 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.



Can Sovereign Metals Raise More Cash Easily?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Sovereign Metals 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. Commonly, a business will sell new shares in itself to raise cash and drive 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).

Sovereign Metals has a market capitalisation of AU$242m and burnt through AU$3.4m last year, which is 1.4% of the company's market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.

Is Sovereign Metals' Cash Burn A Worry?

On this analysis of Sovereign Metals' cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. We don't think its cash burn is particularly problematic, but after considering the range of factors in this article, we do think shareholders should be monitoring how it changes over time. On another note, we conducted an in-depth investigation of the company, and identified 5 warning signs for Sovereign Metals (3 make us uncomfortable!) 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 freelist of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)

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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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