Here's Why We're A Bit Worried About Forum Energy Metals' (CVE:FMC) Cash Burn Situation

We can readily understand why investors are attracted to unprofitable companies. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So should Forum Energy Metals (CVE:FMC) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. 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 Forum Energy Metals

When Might Forum Energy Metals 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. When Forum Energy Metals last reported its balance sheet in May 2022, it had zero debt and cash worth CA$3.4m. Importantly, its cash burn was CA$5.4m over the trailing twelve months. So it had a cash runway of approximately 7 months from May 2022. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. Depicted below, you can see how its cash holdings have changed over time.

How Is Forum Energy Metals' Cash Burn Changing Over Time?

Forum Energy Metals didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Its cash burn positively exploded in the last year, up 254%. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Admittedly, we're a bit cautious of Forum Energy Metals due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Easily Can Forum Energy Metals Raise Cash?

Since its cash burn is moving in the wrong direction, Forum Energy Metals shareholders may wish to think ahead to when the company may need to raise more cash. Companies can raise capital through either debt or equity. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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).

Since it has a market capitalisation of CA$29m, Forum Energy Metals' CA$5.4m in cash burn equates to about 19% of its market value. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.

How Risky Is Forum Energy Metals' Cash Burn Situation?

On this analysis of Forum Energy Metals' cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we'd be watching like a hawk for any deterioration. On another note, Forum Energy Metals has 5 warning signs (and 3 which are potentially serious) we think you should know about.

Of course Forum Energy Metals 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.