There's no doubt that money can be made by owning shares of unprofitable businesses. 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.

So, the natural question for Arafura Resources (ASX:ARU) shareholders is whether they should be concerned by its rate of cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. Let's start with an examination of the business' cash, relative to its cash burn.

See our latest analysis for Arafura Resources

How Long Is Arafura Resources' Cash Runway?

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 Arafura Resources last reported its balance sheet in June 2020, it had zero debt and cash worth AU$23m. Importantly, its cash burn was AU$12m over the trailing twelve months. Therefore, from June 2020 it had roughly 23 months of cash runway. 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. However, if we extrapolate the company's recent cash burn trend, then it would have a longer cash run way. Depicted below, you can see how its cash holdings have changed over time.

How Is Arafura Resources' Cash Burn Changing Over Time?

In our view, Arafura Resources doesn't yet produce significant amounts of operating revenue, since it reported just AU$58k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. With cash burn dropping by 17% it seems management feel the company is spending enough to advance its business plans at an appropriate pace. 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.

How Easily Can Arafura Resources Raise Cash?

While Arafura 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. 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 AU$90m, Arafura Resources' AU$12m in cash burn equates to about 13% of its 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.

Is Arafura Resources' Cash Burn A Worry?

The good news is that in our view Arafura Resources' cash burn situation gives shareholders real reason for optimism. One the one hand we have its solid cash burn relative to its market cap, while on the other it can also boast very strong cash runway. 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 Arafura Resources' situation. Separately, we looked at different risks affecting the company and spotted 5 warning signs for Arafura Resources (of which 1 shouldn't be ignored!) you should know about.

If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.

This article by Simply Wall St is general in nature. 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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