Will Sarama Resources (CVE:SWA) Spend Its Cash Wisely?

We can readily understand why investors are attracted to unprofitable companies. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So, the natural question for Sarama Resources (CVE:SWA) shareholders is whether they should be concerned by its rate of 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

See our latest analysis for Sarama Resources

When Might Sarama Resources 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. In September 2021, Sarama Resources had US$1.6m in cash, and was debt-free. Importantly, its cash burn was US$2.2m over the trailing twelve months. That means it had a cash runway of around 9 months as of September 2021. 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. Depicted below, you can see how its cash holdings have changed over time.

How Is Sarama Resources' Cash Burn Changing Over Time?

Because Sarama Resources isn't currently generating revenue, we consider it an early-stage 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. As it happens, the company's cash burn reduced by 13% over the last year, which suggests that management may be mindful of the risks of their depleting cash reserves. Sarama 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 Sarama Resources To Raise More Cash For Growth?

While Sarama Resources is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash and drive growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.

Sarama Resources has a market capitalisation of US$20m and burnt through US$2.2m last year, which is 11% of the company's market value. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.

So, Should We Worry About Sarama Resources' Cash Burn?

On this analysis of Sarama Resources' cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. Summing up, we think the Sarama Resources' cash burn is a risk, based on the factors we mentioned in this article. On another note, we conducted an in-depth investigation of the company, and identified 6 warning signs for Sarama Resources (3 are concerning!) that you should be aware of before investing here.

Of course Sarama Resources 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.