Here's Why We're Not Too Worried About Sol-Gel Technologies' (NASDAQ:SLGL) Cash Burn Situation

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, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

Given this risk, we thought we'd take a look at whether Sol-Gel Technologies (NASDAQ:SLGL) 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 Sol-Gel Technologies

When Might Sol-Gel Technologies Run Out Of Money?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. When Sol-Gel Technologies last reported its balance sheet in June 2020, it had zero debt and cash worth US$66m. In the last year, its cash burn was US$20m. Therefore, from June 2020 it had 3.3 years of cash runway. Importantly, though, analysts think that Sol-Gel Technologies will reach cashflow breakeven before then. If that happens, then the length of its cash runway, today, would become a moot point. The image below shows how its cash balance has been changing over the last few years.

How Well Is Sol-Gel Technologies Growing?

It was fairly positive to see that Sol-Gel Technologies reduced its cash burn by 31% during the last year. But the revenue dip of 5.9% in the same period was a bit concerning. On balance, we'd say the company is improving over time. Clearly, however, the crucial factor is whether the company will grow its business going forward. 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 Sol-Gel Technologies To Raise More Cash For Growth?

We are certainly impressed with the progress Sol-Gel Technologies has made over the last year, but it is also worth considering how costly it would be if it wanted to raise more cash to fund faster growth. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash and drive 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.

Sol-Gel Technologies' cash burn of US$20m is about 12% of its US$168m market capitalisation. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.

So, Should We Worry About Sol-Gel Technologies' Cash Burn?

It may already be apparent to you that we're relatively comfortable with the way Sol-Gel Technologies is burning through its cash. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. While its falling revenue wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. One real positive is that analysts are forecasting that the company will reach breakeven. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. Readers need to have a sound understanding of business risks before investing in a stock, and we've spotted 3 warning signs for Sol-Gel Technologies that potential shareholders should take into account before putting money into a stock.

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)

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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