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. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

So should Erris Resources (LON:ERIS) shareholders 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). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

See our latest analysis for Erris Resources

Does Erris Resources Have A Long 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. As at June 2019, Erris Resources had cash of €1.9m and no debt. Looking at the last year, the company burnt through €2.3m. That means it had a cash runway of around 10 months as of June 2019. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. The image below shows how its cash balance has been changing over the last few years.

How Is Erris Resources's Cash Burn Changing Over Time?

In our view, Erris Resources doesn't yet produce significant amounts of operating revenue, since it reported just €115k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. As it happens, the company's cash burn reduced by 9.2% over the last year, which suggests that management may be mindful of the risks of their depleting cash reserves. Erris 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.

Can Erris Resources Raise More Cash Easily?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Erris Resources to raise more cash in the future. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash to drive growth. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.

Erris Resources has a market capitalisation of UK£1.5m and burnt through €2.3m last year, which is 129% of the company's market value. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.

So, Should We Worry About Erris Resources's Cash Burn?

Even though its cash burn relative to its market cap makes us a little nervous, we are compelled to mention that we thought Erris Resources's cash burn reduction was relatively promising. After considering the data discussed in this article, we don't have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. We think it's very important to consider the cash burn for loss making companies, but other considerations such as the amount the CEO is paid can also enhance your understanding of the business. You can click here to see what Erris Resources's CEO gets paid each year.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.