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 while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So, the natural question for Sipa Resources (ASX:SRI) 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

Check out our latest analysis for Sipa Resources

How Long Is Sipa Resources's Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at June 2019, Sipa Resources had cash of AU$3.9m and no debt. Importantly, its cash burn was AU$2.3m over the trailing twelve months. So it had a cash runway of approximately 20 months from June 2019. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. You can see how its cash balance has changed over time in the image below.

How Is Sipa Resources's Cash Burn Changing Over Time?

Whilst it's great to see that Sipa Resources has already begun generating revenue from operations, last year it only produced AU$353k, 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. Even though it doesn't get us excited, the 22% reduction in cash burn year on year does suggest the company can continue operating for quite some time. Sipa 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 Sipa Resources To Raise More Cash For Growth?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Sipa Resources to raise more cash in the future. 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.

Sipa Resources has a market capitalisation of AU$12m and burnt through AU$2.3m last year, which is 20% 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.

Is Sipa Resources's Cash Burn A Worry?

On this analysis of Sipa Resources's cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. 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 Sipa 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.

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