Companies Like Sovereign Cloud Holdings (ASX:SOV) Are In A Position To Invest In Growth

There's no doubt that money can be made by owning shares of unprofitable businesses. 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.

So should Sovereign Cloud Holdings (ASX:SOV) shareholders 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'. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

Check out our latest analysis for Sovereign Cloud Holdings

When Might Sovereign Cloud Holdings Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at December 2021, Sovereign Cloud Holdings had cash of AU$41m and no debt. Importantly, its cash burn was AU$7.3m over the trailing twelve months. Therefore, from December 2021 it had 5.6 years of cash runway. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. Depicted below, you can see how its cash holdings have changed over time.

How Well Is Sovereign Cloud Holdings Growing?

It was fairly positive to see that Sovereign Cloud Holdings reduced its cash burn by 22% during the last year. And arguably the operating revenue growth of 73% was even more impressive. It seems to be growing nicely. While the past is always worth studying, it is the future that matters most of all. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

How Easily Can Sovereign Cloud Holdings Raise Cash?

There's no doubt Sovereign Cloud Holdings seems to be in a fairly good position, when it comes to managing its cash burn, but even if it's only hypothetical, it's always worth asking how easily it could raise more money to fund growth. 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 Cloud Holdings' cash burn of AU$7.3m is about 9.1% of its AU$80m 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.

How Risky Is Sovereign Cloud Holdings' Cash Burn Situation?

As you can probably tell by now, we're not too worried about Sovereign Cloud Holdings' cash burn. In particular, we think its revenue growth stands out as evidence that the company is well on top of its spending. Its cash burn reduction wasn't quite as good, but was still rather encouraging! Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. Taking a deeper dive, we've spotted 5 warning signs for Sovereign Cloud Holdings you should be aware of, and 1 of them is potentially serious.

Of course Sovereign Cloud Holdings may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.