There's no doubt that money can be made by owning shares of unprofitable businesses. 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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

So, the natural question for Terns Pharmaceuticals (NASDAQ:TERN) shareholders is whether they should be concerned by its rate of 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). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

How Long Is Terns Pharmaceuticals' 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. As at March 2024, Terns Pharmaceuticals had cash of US$241m and no debt. In the last year, its cash burn was US$76m. So it had a cash runway of about 3.2 years from March 2024. A runway of this length affords the company the time and space it needs to develop the business. Depicted below, you can see how its cash holdings have changed over time.

How Is Terns Pharmaceuticals' Cash Burn Changing Over Time?

Terns Pharmaceuticals didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. During the last twelve months, its cash burn actually ramped up 51%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. 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 Terns Pharmaceuticals Raise More Cash Easily?

Given its cash burn trajectory, Terns Pharmaceuticals shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and 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.

Since it has a market capitalisation of US$516m, Terns Pharmaceuticals' US$76m in cash burn equates to about 15% of its market value. 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.

Is Terns Pharmaceuticals' Cash Burn A Worry?

As you can probably tell by now, we're not too worried about Terns Pharmaceuticals' cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. Although its increasing cash burn does give us reason for pause, the other metrics we discussed in this article form a positive picture overall. 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. On another note, we conducted an in-depth investigation of the company, and identified 5 warning signs for Terns Pharmaceuticals (2 are a bit unpleasant!) that you should be aware of before investing here.

Of course Terns Pharmaceuticals may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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@simplywallst.com