We can readily understand why investors are attracted to unprofitable companies. 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 Cato (NYSE:CATO) shareholders should be worried about its cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. 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 Cato

When Might Cato 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. As at February 2024, Cato had cash of US$103m and no debt. Looking at the last year, the company burnt through US$12m. So it had a cash runway of about 8.5 years from February 2024. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. You can see how its cash balance has changed over time in the image below.

How Well Is Cato Growing?

Notably, Cato actually ramped up its cash burn very hard and fast in the last year, by 120%, signifying heavy investment in the business. While that's concerning on it's own, the fact that operating revenue was actually down 6.9% over the same period makes us positively tremulous. Taken together, we think these growth metrics are a little worrying. In reality, this article only makes a short study of the company's growth data. You can take a look at how Cato has developed its business over time by checking this visualization of its revenue and earnings history.

Can Cato Raise More Cash Easily?

While Cato seems to be in a fairly good position, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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 US$94m, Cato's US$12m in cash burn equates to about 13% 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.

How Risky Is Cato's Cash Burn Situation?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Cato's cash runway was relatively promising. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Cato's situation. Taking a deeper dive, we've spotted 3 warning signs for Cato you should be aware of, and 2 of them are significant.

Of course Cato 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 that insiders are buying.

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

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.