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Analyzing Tesla Liquidity With Only 3 Ratios

Tesla Model 3 interior. Flickr Image.

Tesla’s liquidity is often one of the most scrutinized piece of information. The reason is that there has been a lot of rumors or news or even hypes over the internet about the company going into bankruptcy. Most investors and even some of Tesla’s vehicle owners are concerned about Tesla liquidity due to the unprofitable operation 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 recently been crippled entirely by the COVID-19 outbreak since 2020 and investors are worried about Tesla’s ability to resume productions as well as the demand for its products.

Therefore, a combination of bad news and negative quarterly results have spooked investors. Basically, investors are eager to find out whether Tesla has or will run into any short-term solvency problem. For that reason, we are going to take a look at some of Tesla’s liquidity ratios in this article.

In this post, we will analyze the liquidity of the company with only 3 ratio and they are:
(1) current ratio,
(2) working capital, and
(3) acid test ratio (some call it quick ratio).

These ratio basically measures Tesla’s short-term liquidity which revolves around the company’s ability to pay its commitments when they come due within a year.

So let’s sit tight and read on to find 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 the company.

The current ratio is determined by dividing the current assets with current liabilities and it’s a useful measure of the ability of the 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 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 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, most of its current assets consist of cash and inventory. On the other hand, the large parts of its current liabilities are accounts payable, accrued liabilities and 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 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 new low in early 2018 at 0.73. Current ratio has somewhat remained flat throughout 2018 at an average ratio of 0.80. The deteriorating liquidity in 2018 was not a coincidence as Tesla was ramping the Model 3 production during this period. The company was consuming a lot of capitals during the Model 3 ramp which explains the low liquidity ratio in 2018.

However, the ratio started to tick up since 2018 and continued to increase steadily and reached new high at 1.24 in 1Q 2020. The expanding liquidity can be partly attributed to the improving cash flow when Tesla delivered record numbers of Model 3 between 2018 and 2020.

A current ratio that is above 1.0 indicates that Tesla has sufficient current assets to cover current liabilities that will be due in the next 12 months. As of 1Q 2020, Tesla current ratio of 1.24 shows that the company has enough short-term liquidity to pay for the coming liabilities.

An increasing current ratio between 2018 and 2020 shows that Tesla has been improving its liquidity and thus, boded well for the company’s financial health.

A quick investigation into Tesla’s 1Q 2020 balance sheets revealed that the company has amassed a cash balance to the tune of $8 billion.

Basically the improving current ratio since 2018 has been largely due to the increasing cash and cash equivalents and inventory.

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.

So what was adjusted in calculating the current ratio in the chart above? Basically, the equation to arrive at the current ratio is by dividing total current assets by total current liabilities.

The adjustment was done to the denominator of the equation which is the current liabilities. The reason for the adjustment was that not all current liabilities are created equal. Some of the liabilities such as deferred revenue, customer deposits and resale value guarantees do not affects Tesla’s immediate liquidity as cash has already been received upfront for these liabilities. Besides, these liabilities may not necessary 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 discussed above, these liabilities were excluded from the adjusted current ratio measurement 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 has been reduced.

Other than improved liquidity, the trend of the adjusted current ratio looks almost the same as the one without adjustment. For example, adjusted current ratio slightly declined between 2015 and 2018 and stayed flat throughout 2018.

Since 2018, Tesla’s adjusted liquidity improved and reached new high at 1.52 as of 1Q 2020. As mentioned, the improving current ratio was partly attributed to Tesla’s record numbers of Model 3 deliveries which has contributed to the expanding cash and cash equivalents.

Chart of Tesla’s Working Capital

Tesla working capital

Tesla working capital

The chart above shows Tesla’s quarterly working capital from 2015 to 2020.

Tesla’s working capital shows similar trend as the plot of current ratio. Accordingly, Tesla’s working capital turned positive when current ratio is above 1.0 and vice versa.

You may notice that Tesla’s working capital has shown the worst results during 2018 when all quarterly numbers turned negative, with some quarters reaching more than $2 billion in deficit. As discussed, the negative working capital in 2018 was not a surprise as the company was consuming a lot of resources when it’s ramping the Model 3 production.

However, Tesla’s working capital turned positive in 2019 and reached record high at more than $2.9 billion in 1Q 2020. The improving working capital was a result of a combination of factors such as Tesla’s improving 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

The chart above shows Tesla’s adjusted working capital. Similar to adjusted current ratio, the adjusted working capital has the current liabilities portion of the equation being reduced to reflect the company realistic liquidity.

When Tesla’s current liabilities were adjusted, the working capital shows tremendous improvement from 2015 to 2020. As of 1Q 2020, Tesla’s adjusted working capital reached record number at slightly above $5 billion.

Again, the improving adjusted working capital between 2018 and 2020 was a result of Tesla’s improving cash flow and capital injection.

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 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 non-liquid assets such as inventory and prepaid expenses in the current asset portion of the formula. Therefore, the asset portion of the acid test ratio is mainly made up of highly liquid assets such as cash and cash equivalents and accounts receivable.

Moreover, restricted cash was also removed when measuring 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 “prepaid expenses and other current assets” in 1Q 2020.

Nevertheless, there is no adjustment to the current liabilities portion when measuring the acid test or quick ratio since we want to stress test the company to see how it is performing when only highly liquid assets is 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 total liabilities.

Moreover, Tesla’s acid test ratio has nosedived from its peak of 0.91 in 2Q16 to as low as 0.31 in 2Q18 before recovering to 0.78 in 1Q20. Along the way, Tesla’s quick ratio has stayed at an average ratio of 0.40 during 2018, indicating that the company’s liquid assets were seriously low compared to total short-term liabilities.

This scenario is sort of expected as the company was heavily investing in plants, machinery and personnel between 2017 and 2018 which has consumed vast amount of capitals during this period, causing highly liquid assets to be severely affected.

This low liquidity environment basically requires Tesla to convert its inventory to cash through sales in order to improve liquidity. If somehow the cash conversion cycle is disrupted, Tesla would be seriously running into solvency problems in no time.

In addition, even with liquidity boost throughout 2019 and all the way to 1Q 2020 through sales and debts offering as seen from the improving quick ratio, Tesla’s highly liquid assets such as cash and cash equivalents has been unable to cover all the short-term liabilities.

As such, Tesla near-cash liquidity is dangerously low when only cash and cash equivalents as well as accounts receivable were taken into consideration. Even with a cash balance of as much as $8 billion as of 1Q 2020, Tesla’s liquid assets were still falling short of the required amount to cover all of its short-term liabilities.

Nevertheless, as long as there is demand for the company products, as seen from its surging revenue in recent quarters, Tesla will be doing just fine.

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 liquidity.

Some of the current liabilities used in the calculation of these ratio have been adjusted to exclude some items that may not have an immediate impact on the liquidity of the company.

From the chart, Tesla’s current ratio has been improving since 2018 and reached new high at 1.24 in 1Q 2020.

Similarly, Tesla’s working capital has also shown similar improvement throughout 2019 and reached new high at $2.9 billion in 1Q 2020.

Since 2018, Tesla’s liquidity got a boost from a number of factors such as capital raise through debt and stock offerings as well as improved sales through record Model 3 deliveries. As a result, all liquidity ratios have risen to safe level as of Q1 2020 except for the acid test ratio when only highly liquid assets such as cash and receivables were accounted for.

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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