We can readily understand why investors are attracted to unprofitable companies. 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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

Given this risk, we thought we'd take a look at whether Neovacs (EPA:ALNEV) 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). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

View our latest analysis for Neovacs

When Might Neovacs Run Out Of Money?

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, Neovacs had cash of €3.5m and such minimal debt that we can ignore it for the purposes of this analysis. In the last year, its cash burn was €9.9m. Therefore, from June 2019 it had roughly 4 months of cash runway. With a cash runway that short, we strongly believe that the company must raise cash or else douse its cash burn promptly. Depicted below, you can see how its cash holdings have changed over time.

How Is Neovacs's Cash Burn Changing Over Time?

Although Neovacs reported revenue of €260k last year, it didn't actually have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. Given the length of the cash runway, we'd interpret the 31% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Neovacs 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.

How Hard Would It Be For Neovacs To Raise More Cash For Growth?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Neovacs 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. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.

Neovacs has a market capitalisation of €8.3m and burnt through €9.9m last year, which is 119% of the company's market value. Given just how high that expenditure is, relative to the company's market value, we think there's an elevated risk of funding distress, and we would be very nervous about holding the stock.

So, Should We Worry About Neovacs's Cash Burn?

As you can probably tell by now, we're rather concerned about Neovacs's cash burn. In particular, we think its cash burn relative to its market cap suggests it isn't in a good position to keep funding growth. While not as bad as its cash burn relative to its market cap, its cash burn reduction is also a concern, and considering everything mentioned above, we're struggling to find much to be optimistic about. Looking at the metrics in this article all together, we consider its cash burn situation to be rather dangerous, and likely to cost shareholders one way or the other. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Neovacs CEO receives in total remuneration.

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

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.