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Analyzing Tesla Liquidity With Only 3 Charts

Tesla Model 3 interior. Flickr Image.

Tesla 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 are concerned about Tesla liquidity as the company has actually not been making profit over the years. Moreover, there is a mountain of debt the company is carrying.

I am sure you have heard of Tesla raising capital through stocks and debt offerings in order to boost its cash flow and liquidity. On top of this, Tesla total vehicle deliveries was at the slowest pace in the latest quarter of Q3 2019, growing only at a modest 2% quarter over quarter or 16% year over year.

Therefore, a combination of news and quarterly result like this really spooks investors. Basically, investors are interested to find out whether Tesla has or will run into any solvency problem. For that reason, we are taking a look at the liquidity of Tesla in this article.

In this post, we will analyze the liquidity of the company with only 3 ratio: (1) current ratio, (2) working capital and (3) acid test ratio (some call it quick ratio). I have created 3 charts below that plotted these ratio over a period of time.

From the graphs below, you will get to find out the liquidity of the company over a period of time, whether improving or deteriorating. Of course, when the data show improving results, the company should be fine.

But if the results are deteriorating, they don’t mean that the company will go into bankruptcy ether. It may just be a warning sign. Besides, when things go south, Tesla can always go for the much needed capital through debt and stock offering.

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 short-term liquidity of the company.

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 the company short-term debt paying ability. For example, we can find out from working capital 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 its current liabilities with current assets which are in cash or near cash form.

Acid test ratio (quick ratio) = Current asset / Current liabilities

For Tesla, most of its current assets consist of cash and inventory. On the other hand, the major parts of its current liabilities are accounts payable, accrued liabilities and current portion of long-term debt and capital leases.

Adjusted Current Asset and Current Liabilities

Here is a snapshot of the current asset and current liabilities section of Tesla:

Tesla current asset and liabilities

Tesla current asset and current liabilities in the balance sheet

In calculating these liquidity ratios such as current ratio, working capital and acid test ratio, the current asset will be adjusted to exclude certain items such as the not-so-liquid short-term assets. For example, inventory and prepaid expenses (shown in the snapshot above) are such items. This adjustment is only applicable for the acid test ratio.

In addition, the current liabilities will also be adjusted to exclude a few short-term liabilities such as resale value guarantees, deferred revenue and customer deposits (refer to the above snapshot for these liabilities). The reason for the exclusion is that cash has been received up-front for these liabilities. Besides, these liabilities may not necessary result in future cash payments.

Here is what Tesla 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.

Moreover, for resale value guarantees, there is insignificant number of customers who had exercised their rights of returning the vehicles to Tesla according to the annual report.

Here is another quote from Tesla 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 when calculating all liquidity ratios.

Chart of Tesla Current Ratio

Tesla current ratio

Tesla current ratio

The chart above shows Tesla current ratio for the past 5 years from 2015 to 2019. The current liabilities part of the current ratio equation were stripped off certain items as discussed in prior paragraphs.

The trend of the plot shows that the current ratio has steadily decreased over the past 19 quarters. In 2018, the ratio stayed at around 1.0 throughout the year before bouncing slightly higher to 1.4 in Q3 2019.

At a current ratio of 1.0, Tesla has an amount of current assets that is equal to current liabilities. At this level, Tesla short-term liquidity is dangerously low. Any economic downturn would severely cripple Tesla short-term liquidity.

Fortunately, Tesla short-term liquidity was boosted by a capital raise in Q2 2019 through equity and debt issuance. As a result, Tesla current ratio rose from 1.0 to 1.4 in Q2 2019.

Here is a quote from Tesla quarterly filings dated Q2 2019 regarding the capital raise event:

Cash Flows from Financing Activities
Cash flows provided by financing activities during the six months ended June 30, 2019 consisted primarily of $1.82 billion from the issuance of 2.00% Convertible Senior Notes due in 2024 (“2024 Notes”), net of transaction costs, and $847.4 million from the issuance of common stock, net of underwriting discounts …

As of Q3 2019, Tesla current ratio stayed at roughly 1.4. At this level, Tesla short-term liquidity is doing just fine.

Chart of Tesla Working Capital

Tesla working capital

Tesla working capital

The chart above shows Tesla working capital for the past 19 quarters from 2015 to 2019. Again, the current liabilities part of the working capital equation were stripped off certain items as discussed in prior paragraphs.

Consistent with the current ratio plot, the working capital is also showing a trend of decline over the shown period and has severely dropped to the negative or near negative level in 2018 before drastically rising to $2.5 billion in 2Q19.

As mentioned in prior discussion, the increase in working capital in 2Q 2019 was primarily due to a capital raise. Tesla issued more than $3 billion of stocks and convertible bonds respectively in 2Q 2019 quarter alone.

The following snapshot shows Tesla cash flow from financing activities for the past 6 months ended 2Q19. In the same quarter, Tesla raised capital through equity and debt offerings as shown in the highlighted rectangle.

Tesla capital raise

Tesla capital raise as seen from its cash flow statement

The above snapshot above includes both Q1 and Q2 2019 results.

When Tesla was having negative working capital, the company would be low in liquidity. While a negative working does not necessary mean the company would immediately go bankrupt, it does show that Tesla indeed does not have enough liquid assets such as cash and cash equivalents to cover its short-term liabilities.

Tesla saved itself from the brink of insolvency through capital injection in Q2 2019. As of Q3 2019, Tesla working capital remained high at close to $3 billion.

Tesla Acid Test Ratio (Quick Ratio)

Tesla acid test ratio

Tesla acid test ratio

The chart above shows the acid test ratio of Tesla for the past 5 years from 2015 to 2019. The acid test ratio is also called quick ratio.

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 part of the acid test ratio is mainly made up of highly liquid assets such as cash and cash equivalents and accounts receivable.

In addition, the current liabilities part of the acid test ratio were stripped off certain items as discussed in prior paragraphs.

In line with the current ratio and working capital plot, the acid test ratio has been trending lower especially during 2018 and has dropped way below the 1.0 threshold throughout 2018 and 2019. For example, in most of the quarters in 2018, the acid test ratio has been dangerously low at the 0.5 level.

At the 0.5 threshold, Tesla is not capable of covering its current liabilities with near-cash assets such as cash and cash equivalents. What is worrying is that the company near-cash assets can only cover half of the current liabilities.

This low liquidity environment basically requires Tesla to turn its inventory to cash in order to keep its business running. Without doing that, Tesla would absolutely run into solvency problem. This just shows how critical Tesla vehicle deliveries are in order to convert all that inventory into working capital. If somehow the cash conversion cycle is disrupted, Tesla would be filing bankruptcy in no time.

In addition, even with the liquidity boost in 2Q 2019, Tesla highly liquid assets such as cash and cash equivalents is still not able to cover all the liabilities as shown in the acid test ratio. As such, Tesla near-cash liquidity is dangerously low when only cash and cash equivalents as well as accounts receivable were taken into consideration.

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 analyze the liquidity of Tesla, we look at the current ratio, working capital and acid test ratio (also referred to quick ratio).

The current asset and current liabilities used in the calculation of these ratio have been adjusted to exclude some assets and liabilities that may not have an immediate effect on the liquidity of the company.

From the chart, Tesla current ratio has been declining and has dropped to around 1.0 in 2018 and early 2019 before rising tremendously to 1.4 in 2Q19. The 1.0 ratio indicates that the company barely has enough short-term asset to cover its short-term liabilities.

Tesla liquidity got a boost from capital raise in Q2 2019 through equity and debt offerings. As a result, all liquidity ratios have risen to safe level as of Q3 2019.

In terms of working capital, the figure also has been in the negative or close to zero in 2018 and 2019, signaling that the company has been operating with near negative working capital throughout 2018. However, the company working capital shot up to $2.5 billion in 2Q19 through capital injection.

For the acid test ratio, the plot indicates that Tesla will immediately enter insolvent state if cash conversion cycle were disrupted due to slowing sales as the ratio has been severely under the 1.0 threshold.

References:

1. Financial figures in all charts and tables were obtained from Tesla Quarterly Results.

2. Featured image was obtained from Thomas Hawk and Steve Jurvetson.

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