There's no doubt that money can be made by owning shares of unprofitable businesses. For example, Sierra Oncology (NASDAQ:SRRA) shareholders have done very well over the last year, with the share price soaring by 106%. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

So notwithstanding the buoyant share price, we think it's well worth asking whether Sierra Oncology's cash burn is too risky. In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

See our latest analysis for Sierra Oncology

Does Sierra Oncology 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. When Sierra Oncology last reported its balance sheet in March 2021, it had zero debt and cash worth US$108m. Importantly, its cash burn was US$55m over the trailing twelve months. So it had a cash runway of approximately 23 months from March 2021. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. You can see how its cash balance has changed over time in the image below.

How Is Sierra Oncology's Cash Burn Changing Over Time?

In our view, Sierra Oncology doesn't yet produce significant amounts of operating revenue, since it reported just US$300k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Over the last year its cash burn actually increased by 12%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. While the past is always worth studying, it is the future that matters most of all. So you might want to take a peek at how much the company is expected to grow in the next few years.

Can Sierra Oncology Raise More Cash Easily?

While Sierra Oncology 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. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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.

Since it has a market capitalisation of US$278m, Sierra Oncology's US$55m in cash burn equates to about 20% 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 Sierra Oncology's Cash Burn A Worry?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Sierra Oncology's cash runway was relatively promising. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. Taking a deeper dive, we've spotted 3 warning signs for Sierra Oncology you should be aware of, and 1 of them doesn't sit too well with us.

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)

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.