Liquidity is king when it comes to the life or death of a business. Without liquidity or cash flow, a profitable business can still succumb to bankruptcy. It’s no exception for General Motors (NYSE:GM) especially when it’s an assets-heavy auto manufacturing company that runs on huge working capital.
As you will see in the following charts, one of GM’s liquidity ratios shows that the company has, in fact, boosted its cash flow substantially through debts during the coronavirus crisis, indicating that the company will do whatever is necessary and at any cost to increase its liquidity even if it meant shouldering more debts.
Moreover, to boost its liquidity, GM has also suspended its share buyback program as well as the dividends payout indefinitely. This situation shows just how critical the liquidity is for GM especially when the company anticipates a possible liquidity crunch in the near future.
In this article, we will look at General Motors’ liquidity ratios from the perspective of current ratio, working capital and quick ratio (or acid test ratio). Keep in mind that these ratios are meant to check on the company’s short-term liquidity, usually within a year from the reported date of the company’s financial filings.
So, just sit tight and keep reading!
General Motors’ Current Ratio
The chart above shows GM’s current ratio which is derived by dividing the company’s total current assets with current liabilities.
The current ratio is meant to measure the company’s short-term liquidity as it involves only variables such as current assets and current liabilities in the balance sheets.
According to the chart, GM’s current ratio had been consistently below 1.0 in most quarterly results, indicating that the company’s total current assets had been barely enough to cover the short-term liabilities in those quarters.
For instance, between 2016 and 2019, the average current ratio was around 0.95 which was slightly below the safe ratio of 1.0. The current ratio has even declined to 0.90 in 4Q19, making the company to look as if it was short on liquidity.
Looking at the result, one might actually think that GM has not been able to cover its short-term liabilities with its current assets.
However, the actual case was that GM has been able to deal with the liabilities that came due all the while. In this aspect, we just have to look at the company’s cash flow generation. GM’s cash flow generation has been so powerful that the company does not need to carry a large chunk of liquidity in its balance sheet to cover the respective liabilities.
Instead, GM only needs to carry the right amount of cash to pay for all the debts that come due within a year.
This scenario can be further verified by looking at GM’s price to free cash flow ratio in which the ratio was at a historically low as of July 2020, illustrating that the company has been able to generate strong free cash flow despite a deteriorating business environment.
However, during the COVID-19 crisis which has badly affected the automobile industry, GM has shored up liquidy, causing the current ratio to tick significantly higher to nearly 1.1 in 1Q 2020.
In a time of crisis like the coronavirus pandemic, GM was shoring up its liquidity in preparation for a worst-case scenario.
In short, my opinion is that do not be misled by the below-average current ratio which makes GM looking as though it was short of liquidity. In the actual case, the company’s cash flow generation capability has been so powerful that it only needs to carry the minimum cash on hand when paying off the company’s short-term liabilities.
General Motors’ Working Capital
The chart above shows GM’s working capital between 2015 and 2020.
Looking at the chart, the trend of GM’s working capital looks quite similar to the trend of the current ratio.
During good times such as between 2015 and 2019 when the company was making good profits, GM’s working capital had been mostly negative, suggesting that the company did not require plenty of working capital.
Similarly, GM has been able to generate enough cash flow to cover the day-to-day business operations.
Again, GM was seen shoring up its working capital in 1Q 2020 when the figure increased drastically to more than $6 billion in preparation for any worst-case scenario during the COVID-19 crisis.
In short, GM only increases its working capital in a time of crisis when the company anticipates a possible liquidity crunch driven by the coronavirus pandemic.
General Motors’ Quick Ratio
Lastly, the quick ratio or acid test ratio measures GM’s short-term liquidity by excluding certain items such as inventory and other short-term assets that are considered not as liquid as cash and cash equivalents.
The quick ratio is similar to the current ratio but is a more refined version of the current ratio. Besides, the quick ratio takes into account only liquid assets such as cash and cash equivalents, marketable securities, accounts receivable, etc while excluding not-so-liquid assets such as inventory.
According to the above chart, GM’s quick ratio has been below 1.0 from 2015 to 2020, suggesting that the company’s liquid assets had not been enough to cover all short-term liabilities.
This situation is sort of expected as even with non-liquid assets included such as the inventory, GM still failed to cover the total short-term liabilities.
Similarly, GM’s quick ratio was seen ticking higher in 1Q 2020 when the company increased its liquidity, which in this case, had been mostly cash and cash equivalents.
Although the company’s quick ratio was considerably higher as of Q1 2020, it was still far from the safe level of 1.0 when adequate liquid assets were able to cover the total current liabilities.
As a result, General Motors still carried certain risks when the respective quick ratio was significantly below the 1.0 ratio. If a liquidity crunch did occur as a result of an external shock, GM may run into a liquidity problem.
Fortunately, we are not anywhere in this situation as GM has acted swiftly during the COVID-19 outbreak by increasing its cash flow as reflected from all the higher liquidity ratios as of 1Q 2020.
The takeaway is that all GM liquidity ratios such as the current ratio, working capital and quick ratio have been below the 1.0 level for a while, indicating that the company may not need to carry plenty of cash in its balance sheets.
This scenario can be validated by the decreasing price to free cash flow ratio which has reached a historic low as of July 2020.
During the coronavirus crisis, GM was seen boosting its liquidity significantly as reflected from the higher current ratio, working capital ratio as well as the higher quick ratio as of 1Q 2020.
Nevertheless, investors still need to keep an eye on all of the liquidity ratios in the coming quarterly results to find out how GM will perform when it comes to liquidity.
References and Credits
1. All financial numbers in the charts in this article were obtained and referenced from annual and quarterly filings available in GM Investor Relation.
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