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. 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.

Given this risk, we thought we'd take a look at whether Danakali (ASX:DNK) shareholders should be worried about its cash burn. 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.

Check out our latest analysis for Danakali

Does Danakali 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 Danakali last reported its balance sheet in December 2020, it had zero debt and cash worth AU$9.7m. Importantly, its cash burn was AU$2.9m over the trailing twelve months. Therefore, from December 2020 it had 3.4 years of cash runway. Importantly, analysts think that Danakali will reach cashflow breakeven in 4 years. So there's a very good chance it won't need more cash, when you consider the burn rate will be reducing in that period. Depicted below, you can see how its cash holdings have changed over time.

How Is Danakali's Cash Burn Changing Over Time?

While Danakali did record statutory revenue of AU$118k over the last year, it didn't have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. With the cash burn rate up 14% in the last year, it seems that the company is ratcheting up investment in the business over time. 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.

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

While Danakali 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. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash and 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.

Since it has a market capitalisation of AU$176m, Danakali's AU$2.9m in cash burn equates to about 1.6% of its market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.

How Risky Is Danakali's Cash Burn Situation?

As you can probably tell by now, we're not too worried about Danakali's cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. Shareholders can take heart from the fact that analysts are forecasting it will reach breakeven. Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. On another note, we conducted an in-depth investigation of the company, and identified 5 warning signs for Danakali (2 shouldn't be ignored!) that you should be aware of before investing here.

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.

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