Just because a business does not make any money, does not mean that the stock will go down. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So, the natural question for S2Medical (STO:S2M) shareholders is whether they should be concerned by its rate of cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

Check out our latest analysis for S2Medical

How Long Is S2Medical's Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. S2Medical has such a small amount of debt that we'll set it aside, and focus on the kr21m in cash it held at September 2019. In the last year, its cash burn was kr22m. So it had a cash runway of approximately 12 months from September 2019. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. You can see how its cash balance has changed over time in the image below.

How Is S2Medical's Cash Burn Changing Over Time?

Whilst it's great to see that S2Medical has already begun generating revenue from operations, last year it only produced kr6.7m, so we don't think it is generating significant revenue, at this point. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. The skyrocketing cash burn up 117% year on year certainly tests our nerves. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Admittedly, we're a bit cautious of S2Medical due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.

How Easily Can S2Medical Raise Cash?

Given its cash burn trajectory, S2Medical shareholders should already be thinking about how easy it might be for it to raise further 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).

S2Medical's cash burn of kr22m is about 25% of its kr86m market capitalisation. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.

So, Should We Worry About S2Medical's Cash Burn?

S2Medical is not in a great position when it comes to its cash burn situation. Although we can understand if some shareholders find its cash runway acceptable, we can't ignore the fact that we consider its increasing cash burn to be downright troublesome. Summing up, we think the S2Medical's cash burn is a risk, based on the factors we mentioned in this article. 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 S2Medical'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.

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.

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