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Analyzing Tesla Liquidity With Only 3 Ratios

Tesla Model 3 interior. Flickr Image.

Tesla’s liquidity is often a hot topic among not only investors but also vehicle owners.

The reason being that there has been a lot of rumors or news or even hypes about the company going out of business soon.

Most investors and even some of Tesla’s vehicle owners are concerned about the company’s financial well-being due to the unprofitable operations that the company has been running.

Moreover, there is a mountain of debts that the company is carrying.

On top of this, the automotive industry has also been seriously impacted by the COVID-19 outbreak, causing automakers like Tesla and General Motors to temporarily suspend some of their productions.

Since automotive products are cyclical and considered non-essential, investors are also worried about the demand for Tesla’s products when unemployment rates are at an all-time high, due mainly to the COVID-19 pandemic.

Therefore, a combination of bad news and negative economic data has really spooked investors.

Basically, investors are eager to find out whether Tesla has or will run into any short-term solvency problem.

In this article, we are going to take a look at some of Tesla’s liquidity ratios.

That said, we will analyze Tesla’s short-term liquidity with only 3 ratio and they are:

(1) current ratio,
(2) working capital, and
(3) acid test ratio (some call it quick ratio).

These ratios basically measure Tesla’s short-term liquidity which boils down to the company’s ability to pay its commitments when they come due within a year.

If Tesla failed to meet these short-term commitments, it will be in serious trouble.

Without further ado, let’s check them out!

Current Ratio, Working Capital and Acid Test Ratio (Quick Ratio)

Investors are often interested in the current assets and current liabilities when evaluating the short-term liquidity of a company.

Particularly, investors look at the current ratio, working capital and acid test ratio which measure the short-term financial health of a company.

The current ratio is determined by dividing the current assets with current liabilities and it’s a useful measure of the ability of a company to cover all the commitments that will come due within a year.

Current ratio = Current assets / Current liabilities

Similarly, the working capital can be determined by subtracting the current liabilities from the current asset to arrive at a figure that measures how much short-term assets are left after accounting for all of the short-term liabilities.

Basically, working capital is the net current assets of a company.

For example, we can find out from the working capital ratio how much is left in current assets after all current liabilities are paid off.

Working capital = Current assets – Current liabilities

Lastly, the acid test ratio or quick ratio is similar to the current ratio except that it is a more refined calculation where non-liquid assets such as the inventory and prepaid expenses are excluded in the asset part of the equation.

The ratio indicates a company’s immediate ability to repay all current liabilities with current assets which are cash or near cash forms.

Acid test ratio (quick ratio) = Current asset (only liquid assets) / Current liabilities

For Tesla, its current assets are mostly made up of cash and inventory.

On the other hand, its current liabilities are mostly made up of accounts payable, accrued liabilities and the current portion of long-term debt and capital leases.

Chart of Tesla’s Current Ratio

Tesla current ratio

Tesla current ratio

The chart above shows Tesla’s quarterly current ratio, calculated using the above equation, for the past 5 years from 2015 to 2020.

The trend of the plot shows that the current ratio has decreased since 2015 and reached a new low in early 2018 at 0.73.

The current ratio has somewhat remained flat throughout 2018 at an average ratio of 0.80.

The deteriorating liquidity in 2018 was not a coincidence but a result of Tesla’s aggressive ramp-up of the Model 3 production and delivery during this period.

The company was consuming a lot of cash during the Model 3 ramp-up which explains the low liquidity ratio in 2018.

However, the ratio started to improve in 2018 and continued to tick higher steadily and reached a new high at 1.63 in 3Q 2020, signaling improving liquidity for Tesla.

The improvement in liquidity ratio can be partly attributed to the expanding cash flow due mainly to Tesla’s record number of delivery of Model 3 between 2018 and 2020.

The expanding cash flow has injected tonnes of cash and cash equivalents into Tesla’s coffers.

A quick investigation into Tesla’s 3Q 2020 balance sheets revealed that the company has amassed a cash balance valuing at $14.5 billion, roughly 40% higher compared to the prior quarter.

The surge in cash and cash equivalents has resulted in a current ratio exceeding 1.0 for Tesla.

A current ratio above 1.0 indicates that Tesla has sufficient current assets to cover the respective current liabilities that will be due in the next 12 months.

As of 2020 3Q, Tesla’s current ratio surged to an all-time high of 1.63, illustrating sufficient liquid assets to cover all the coming debts.

In short, Tesla’s improved liquidity is attributed mainly to cash generated from sales of Model 3 and the addition of cash and cash equivalents in its balance sheets.

Chart of Tesla’s Adjusted Current Ratio

Tesla adjusted current ratio

Tesla adjusted current ratio

The chart above shows Tesla’s quarterly adjusted current ratio between 2015 and 2020.

The adjustment is made at the current liabilities because not all current liabilities are created equal.

For example, some of the current liabilities such as the deferred revenue, customer deposits and resale value guarantees do not affect Tesla’s immediate liquidity as cash has already been received upfront for these liabilities.

Besides, these liabilities may not necessarily result in future cash payments.

Here is what Tesla has said about the resale value guarantee in its annual filing dated Dec 31 2018:

Vehicles deliveries with resale value guarantee do not impact our near-term cash flows and liquidity, since we received the full amount of cash for the vehicle sale price at delivery.

Here is another quote from Tesla’s annual filings dated Dec 31 2018 regarding resale value guarantee:

To date, we have only had an insignificant number of customers who exercised their resale value guarantees and returned their vehicles to us. Based on current market demand for our vehicles, we estimate the market prices of our vehicles will continue to be above our resale value guarantee amounts.

For the reason mentioned above, these liabilities were excluded from the adjusted current ratio to reflect Tesla’s realistic liquidity.

Coming back to the chart, the adjusted current ratio shows Tesla’s improved liquidity. This is expected as the current liabilities have been reduced.

Other than improved liquidity, the trend of the adjusted current ratio looks almost the same as the one without adjustment.

For example, the adjusted current ratio slightly declined between 2015 and 2018 and stayed flat throughout 2018.

From 2018 and onward, Tesla’s adjusted current ratio has improved tremendously and reached a new high of 1.92 as of 3Q 2020, indicating the improving fundamentals for the company.

As discussed, the expanding current ratio has been partly attributed to Tesla’s record numbers of Model 3 deliveries all these years which has resulted in the injection of tonnes of cash and cash equivalents into the balance sheets.

Chart of Tesla’s Working Capital

Tesla working capital

Tesla working capital

Tesla’s working capital shows a similar trend as the plot of the current ratio.

Accordingly, Tesla’s working capital turned positive when the current ratio is above 1.0 and vice versa.

You may notice that Tesla’s working capital was the lowest in 2018 when all quarterly numbers turned negative, with some quarters even reaching as low as -$2 billion.

As discussed, the negative working capital in 2018 was not a surprise but a result of the consumption of huge working capital during the initial stage of Tesla’s Model 3 ramp-up.

However, Tesla’s working capital turned positive in 2019 and reached a record high at more than $8 billion in Q3 2020 when Tesla sold a record number of Model 3 that has generated tonnes of cash for the company.

The improved working capital has been a result of several factors, including Tesla’s positive cash flow and capital raise between 2018 and 2020.

Whatever the reason is, the improving liquidity bodes well for the company’s financial well-being.

Chart of Tesla’s Adjusted Working Capital

Tesla adjusted  working capital

Tesla adjusted working capital

On an adjusted basis, Tesla’s working capital improved tremendously, reaching as much as $10 billion in 2020 3Q.

Similar to the adjusted current ratio, the adjustment for working capital is done at the current liabilities portion to reflect Tesla’s realistic liabilities.

Again, the surging adjusted working capital from 2019 to 2020 has been a result of Tesla’s positive cash flow and capital injection.

For your information, Tesla’s cash and cash equivalents totaled more than $14 billion as of Q3 2020, pushing the adjusted working capital to its highest level during the same quarter.

Tesla Acid Test Ratio (Quick Ratio)

Tesla acid test or quick ratio

Tesla acid test or quick ratio

The chart above shows Tesla’s acid test ratio or quick ratio for the past 5 years from 2015 to 2020.

As briefly mentioned at the start of the article, the acid test ratio is calculated by excluding some of the non-liquid assets, including the inventory and prepaid expenses in the current asset portion of the formula.

By excluding these non-liquid current assets, the acid test ratio is now made up of only liquid assets such as cash and cash equivalents and accounts receivable.

Moreover, restricted cash was also removed when calculating the acid test or quick ratio to give a truer sense of Tesla’s liquidity.

There is justification in removing the restricted cash as Tesla has classified restricted cash as part of the “prepaid expenses and other current assets” in 1Q 2020, which means the restricted cash is not so liquid after all.

However, we do not make adjustments to the current liabilities portion when measuring the acid test or quick ratio.

The reason is that we want to stress-test the company to see how it performs when only highly liquid assets are pitted against total short-term liabilities.

As the chart shows, Tesla’s acid test ratio has been mostly below 1.0 over the past 5 years, indicating that the company’s liquid assets alone such as cash and cash equivalents had not been sufficient to cover its short-term liabilities.

Moreover, Tesla’s acid test ratio dipped to less than 0.5 in 2018, driven primarily by huge spendings between 2018 and 2019.

While Tesla’s acid test ratio slowly improved in 2019 compared to the prior year, the figures were still below 1.0, illustrating that the company’s highly liquid assets still failed to cover all short-term liabilities.

This low liquidity environment basically requires Tesla to convert some of its inventory to cash through sales in order to generate cash to improve liquidity.

Fortunately, Tesla had been able to do so as seen from the increased cash and cash equivalent throughout 2020.

If Tesla had failed to perform the cash conversion cycle, it would be running into solvency problems in no time.

As of 2020 3Q, Tesla’s acid test ratio surged beyond 1.0 for the 1st time and reached 1.22, signaling the improved liquidity despite considering only liquid assets.

In short, Tesla has managed to turn its business around from being cash-strapped to a cash cow as of Q3 2020.

Conclusion

To recap, we looked at the current ratio, working capital and acid test ratio (also referred to quick ratio) when we analyzed Tesla’s short-term liquidity.

Some current liabilities used in the calculation of these ratios have been adjusted to exclude certain items that may not have an immediate impact on the cash flow of the company.

For example, cash has been received upfront for the deferred revenue liability. As such, it can be excluded when accounting for Tesla’s realistic liquidity.

From the chart, Tesla’s current ratio has been improving since 2018 and reached a new high at 1.63 in Q3 2020.

Similarly, Tesla’s working capital has also shown similar improvement throughout 2019 and reached a new high of more than $8 billion in Q3 2020.

Tesla’s quick ratio surged past 1.0 for the 1st time and reached 1.22 in 2020 3Q, boosted by surging cash and cash equivalents in the same quarter.

Since 2018, Tesla’s liquidity got a boost from a number of factors, including capital raise through debt and stock offerings as well as record sales through Model 3 deliveries.

As a result, all liquidity ratios have risen to a safe level as of Q3 2020, indicating that there is no immediate solvency problem for the company.

References:

1. Financial data in all charts and tables in this article were obtained and referenced from Tesla’s financial statements available in Tesla Quarterly Results.

2. Featured images in this article are used under creative commons license and sourced from the following websites: Thomas Hawk and Steve Jurvetson.

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