We Think Diffusion Pharmaceuticals (NASDAQ:DFFN) Needs To Drive Business Growth Carefully

Just because a business does not make any money, does not mean that the stock will go down. 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 Diffusion Pharmaceuticals (NASDAQ:DFFN) 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). 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 Diffusion Pharmaceuticals

How Long Is Diffusion Pharmaceuticals' Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Diffusion Pharmaceuticals last reported its balance sheet in September 2021, it had zero debt and cash worth US$40m. Importantly, its cash burn was US$15m over the trailing twelve months. That means it had a cash runway of about 2.7 years as of September 2021. Arguably, that's a prudent and sensible length of runway to have. The image below shows how its cash balance has been changing over the last few years.

How Is Diffusion Pharmaceuticals' Cash Burn Changing Over Time?

Diffusion Pharmaceuticals 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. With the cash burn rate up 18% in the last year, it seems that the company is ratcheting up investment in the business over time. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. 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 Diffusion Pharmaceuticals Raise Cash?

While Diffusion Pharmaceuticals does have a solid cash runway, its cash burn trajectory may have some shareholders thinking 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 US$24m, Diffusion Pharmaceuticals' US$15m in cash burn equates to about 63% of its market value. That's very high expenditure relative to the company's size, suggesting it is an extremely high risk stock.

How Risky Is Diffusion Pharmaceuticals' Cash Burn Situation?

Even though its cash burn relative to its market cap makes us a little nervous, we are compelled to mention that we thought Diffusion Pharmaceuticals' cash runway was relatively promising. Even though we don't think it has a problem with its cash burn, the analysis we've done in this article does suggest that shareholders should give some careful thought to the potential cost of raising more money in the future. Taking a deeper dive, we've spotted 4 warning signs for Diffusion Pharmaceuticals you should be aware of, and 1 of them is concerning.

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.