Here's Why We're Not Too Worried About Emmerson's (LON:EML) Cash Burn Situation

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, 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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

Given this risk, we thought we'd take a look at whether Emmerson (LON:EML) shareholders should be worried about its cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). Let's start with an examination of the business' cash, relative to its cash burn.

Check out our latest analysis for Emmerson

Does Emmerson Have A Long Cash Runway?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. As at June 2021, Emmerson had cash of UK£4.6m and no debt. Looking at the last year, the company burnt through UK£2.9m. That means it had a cash runway of around 19 months as of June 2021. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. Importantly, if we extrapolate recent cash burn trends, the cash runway would be noticeably longer. You can see how its cash balance has changed over time in the image below.

How Is Emmerson's Cash Burn Changing Over Time?

Emmerson 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. As it happens, the company's cash burn reduced by 7.9% over the last year, which suggests that management are maintaining a fairly steady rate of business development, albeit with a slight decrease in spending. Admittedly, we're a bit cautious of Emmerson 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 Emmerson Raise Cash?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Emmerson 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. 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).

Emmerson's cash burn of UK£2.9m is about 6.8% of its UK£42m 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 Emmerson's Cash Burn Situation?

Emmerson appears to be in pretty good health when it comes to its cash burn situation. One the one hand we have its solid cash runway, while on the other it can also boast very strong cash burn relative to its market cap. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Emmerson's situation. On another note, Emmerson has 5 warning signs (and 2 which make us uncomfortable) we think 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)

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.

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