Here's Why We're Watching Legend Power Systems' (CVE:LPS) Cash Burn Situation

We can readily understand why investors are attracted to unprofitable companies. 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?

Given this risk, we thought we'd take a look at whether Legend Power Systems (CVE:LPS) shareholders should 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. Let's start with an examination of the business' cash, relative to its cash burn.

See our latest analysis for Legend Power Systems

When Might Legend Power Systems 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. As at June 2022, Legend Power Systems had cash of CA$4.7m and no debt. In the last year, its cash burn was CA$5.6m. Therefore, from June 2022 it had roughly 10 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. Depicted below, you can see how its cash holdings have changed over time.

How Well Is Legend Power Systems Growing?

Notably, Legend Power Systems actually ramped up its cash burn very hard and fast in the last year, by 130%, signifying heavy investment in the business. As if that's not bad enough, the operating revenue also dropped by 40%, making us very wary indeed. Considering these two factors together makes us nervous about the direction the company seems to be heading. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

Can Legend Power Systems Raise More Cash Easily?

Since Legend Power Systems can't yet boast improving growth metrics, the market will likely be considering how it can raise more cash if need be. 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).

Legend Power Systems has a market capitalisation of CA$29m and burnt through CA$5.6m last year, which is 19% of the company's 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.

Is Legend Power Systems' Cash Burn A Worry?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Legend Power Systems' cash burn relative to its market cap was relatively promising. 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. Separately, we looked at different risks affecting the company and spotted 4 warning signs for Legend Power Systems (of which 2 are concerning!) you should know about.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)

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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.