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Analyzing Tesla Liquidity With Only 3 Ratios

Tesla Model 3 interior. Flickr Image.

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

Tesla may go out of business if it faces liquidity issues.

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

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

On top of this, the automotive industry has also been negatively impacted by the COVID-19 outbreak, causing automakers like Tesla and General Motors alike having 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 disruption.

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

In general, most investors are eager to know how Tesla has been doing when it comes to liquidity and whether the company 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 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 the 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

* Current ratio comes from the author’s own calculation.
* Both current assets and current liabilities used in the ratio are GAAP measures which come directly from Tesla’s quarterly and annual statements.

The chart above shows Tesla’s quarterly current ratio, calculated using the above equation, for the period 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 1.88 in 4Q 2020, signaling improving liquidity for Tesla.

The improvement in liquidity ratio can also be attributed to the expanding cash flow, driven mainly by 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 4Q 2020 balance sheets revealed that the company has amassed a cash balance valuing at $19 billion, roughly 27% higher compared to the prior quarter.

The surge in cash and cash equivalents has resulted in a current ratio reaching nearly 2.0 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 4Q, Tesla’s current ratio surged to an all-time high of 1.88, illustrating sufficient liquid assets to pay for all coming debts.

In short, Tesla’s improved liquidity is attributed mainly to cash generated from sales of Model 3/Y 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

* Adjusted current ratio comes from the author’s own calculation.
* Adjusted current liabilities used in the ratio are non-GAAP measures and comes from the author’s own calculation.
* Current assets are GAAP measures and were extracted from Tesla’s quarterly and annual statements.

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.

All told, the adjusted current ratio shows Tesla’s improved liquidity compared to the non-adjusted ratio.

This is expected as the current liabilities have been reduced in the adjusted ratio.

As of 2020 4Q, Tesla’s adjusted current ratio reached a new high at 2.22, slightly higher than the non-adjusted ratio.

In reality, Tesla’s liquidity is much better than you would normally expect.

As mentioned, the expanding current ratio has been partly attributed to Tesla’s record numbers of Model 3/Y deliveries all these years.

The record deliveries have injected tonnes of cash into Tesla’s balance sheets and hence, the improving liquidity.

Chart of Tesla’s Working Capital

Tesla working capital

Tesla working capital

* Working capital comes from the author’s own calculation.
* Both current assets and current liabilities are GAAP measures and were extracted from Tesla’s quarterly and annual statements.

Tesla’s working capital shows a similar uptrend in 2020.

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 $12.5 billion in Q4 2020 driven by Tesla’s record number of Model 3/Y deliveries that 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

* Adjusted working capital comes from the author’s own calculation.
* The adjusted current liabilities is a non-GAAP measure and comes from the author’s own calculation.

On an adjusted basis, Tesla’s working capital improved tremendously, reaching as much as $14.7 billion in 2020 4Q.

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 $19 billion as of Q4 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

* Acid test ratio comes from the author’s own calculation.
* Adjusted current assets is a non-GAAP measure and comes from the author’s own calculation.

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

As briefly mentioned at the start of the article, the acid test ratio is calculated by excluding certain 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 to stress test Tesla’s liquidity.

On the liabilities side, we do not adjust any current liabilities portion when arriving at the acid test or quick ratio.

We are stress-testing Tesla’s liquidity to see how it performs when only highly liquid assets are pitted against the entire short-term liabilities.

According to the chart, Tesla used to have a quick ratio or acid test ratio below 1.0, indicating that the company’s liquid assets alone such as cash and cash equivalents was insufficient to cover its entire short-term liabilities.

The worst occurred in 2018 when Tesla’s quick ratio dipped below 0.5 in 2018, driven primarily by huge spendings and cash outflow in the same year.

However, Tesla’s liquidity slowly improved in 2019 compared to the prior year as seen from the higher quick ratio.

While improving, Tesla’s quick ratio was still below 1.0 in 2019.

Moving forward, Tesla’s liquidity continued to soar and for the 1st time in 2020 3Q, Tesla’s quick ratio reached 1.22, indicating that the company’s highly liquid assets alone were able to pay for the entire short-term liabilities.

As of 4Q 2020, Tesla’s quick ratio continued to surge and reached a record high of 1.49, driven primarily by the surge in cash and cash equivalents.

For the 1st time, Tesla has enough cash and cash equivalents that can pay for the entire short-term liabilities that will come due in the next 12 months.

All in all, Tesla has managed to turn its business around from being cash-strapped to a cash cow in 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 as they may not have an immediate impact on the cash flow.

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

From the results of these ratios, Tesla’s liquidity has improved tremendously and is considered at a safe level as of 4Q 2020.

During the stress testing as measured by the quick ratio, Tesla’s cash and cash equivalents alone are sufficient to pay for the entire short-term liabilities that come due within the next 12 months.

In short, Tesla has no immediate solvency problem as of now.

References:

1. Financial data in this article was obtained and referenced from Tesla’s financial statements available in Tesla Quarterly and Annual Results.

2. Ratios came from the author’s own calculation.

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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