With Tesla reporting both negative cash flow and large profit losses, Goldman Sachs recently lowered TSLA stock from $205 to $195, giving it a "sell" rating. Plus, in a recent report from The Economist, expert analysts from Jeffries estimated that Tesla will face serious cash flow issues this year, if the company cannot raise at least $2.5 to $3 billion in additional working capital. Facing this magnitude of a potential cash shortage, one might expect the company's CEO to (at the very least) break a sweat.
In response, however, Elon Musk coolly tweeted, "The Economist used to be boring, but smart with a wicked dry wit. Now it’s just boring (sigh). Tesla will be profitable [and] cash flow [positive] in Q3 & Q4, so [obviously] no need to raise money."
So, what exactly is Musk's secret weapon for improving cash flow for Tesla? How does he plan to do it, and what have they done in the past?
If you know anything about healthy cash flow, then you know it is a delicate balance between the rate and timing of cash coming in and going out. A company's burn rate, is the speed at which cash is reduced, sometimes expressed in dollars per day. The burn rate can be slowed in two ways: either by reducing the rate at which money leaves the company or by increasing the amount of money flowing into the company.
If money is leaving a company more quickly than the company is making money, then that business has a negative cash flow. If money comes into a business faster than it leaves, then the company has a positive cash flow.
In the past, Tesla has solved cash flow problems by raising more capital by selling equity. The company also has the ability to raise working capital by dramatically (we're talking debt in the billions of dollars range) increasing the amount of debt they carry. In other words, a company the size of Tesla has several options for solving cash flow issues. Some methods, however, are smarter, available to all types and sizes of businesses for use and require just a little more creativity than asking someone else to cover your cash flow shortage.
• Increase Customer Deposits - Tesla accepts customer deposits on products that have not yet been produced. For example, when they released plans to build a new Tesla roadster and a Tesla semi truck, the company's customer deposits increased by about $168.7 million.
Depending on your type of business, you can improve cash flow by decreasing days sales outstanding by asking clients for deposits up front to cover a portion of the future products or services they will receive. This type of cash flow improvement, however, is not always sustainable. For example, if you run Tesla, you can only release plans for a limited number of new products over the course of a year. If you run a different type of business, you can only increase the amount of a customer deposits so much before customers are either paying in full up front or you are forced to increase your prices.
• Increasing Production Rates - Tesla management has reported that the production level of Model 3s, which they need to achieve in order to reach the margins necessary to turn losses into profits, is 5,000 units per week. At this production rate, Tesla will reach a 25% margin on Model 3 vehicles, the number the company needs for sustainable operation. With accurate and timely financial statements, you can calculate your company's gross profit margin and contribution margin to set a goal and determine a sustainable margin.
Using time-driven activity-based costing (TDABC), your company can also determine the production rates necessary to achieve a sustainable business model.
• Basically, Zero Work in Progress Days - For Tesla, production rates – rather than inventory parked in a showroom, waiting to be sold – seem to be one of their primary cash flow concerns. In other words, they are selling their products before they are even produced. This is especially true for their clean energy kits for homes and businesses, which currently have a three to six-month production lag. Other companies, however, that must maintain and sell inventory or even if the business provides services to be profitable should look for ways to reduce their work-in-progress days, or the number of days a product sits on a shelf before it is sold. Each day a car, a painting, or service plan or wears a price tag, waiting to be purchased, that costs your business money.
• Optimize the Cash Flow Cycle - Although the company does not always release a cash flow statement with its shareholder letters, choosing to refrain from making their cash flow completely public knowledge, Tesla seems to tighten its cash flow cycle when in a pinch. In other words, they lengthen the amount of time before they must pay their bills (maximized accounts payable days) and shorten the time before they get paid (minimized accounts receivable days). You can also do this in your business.
It sometimes makes sense to pay bills right away, especially when offered a discount for early payment. Sometimes, however, it is smarter to hold onto your cash (until you must make payments to avoid late fees and penalties) in order to leverage it on items that will generate more cash flow, such as purchasing more inventory or ramping up production.
The best way for Tesla's finance experts and every business owner to manage their cash flow concerns is by using management accounting and cash flow forecasting to anticipate issues and address them before they become true cash flow problems.
Management accounting allows a company to move beyond back office payroll, A/R, A/P, tax filing and other bookkeeping activities, and to start to leverage their financial intelligence by measuring and tracking financial trends, optimizing operations, improving cash flow and increasing profits.
Although Tesla has thus far managed to find success, while facing negative cash flow and losses time and time again, not all businesses (including yours) have to operate under such pressure in order to find success and become more profitable. You do need to understand your cash flow and develop a cash management process that leverages your best options.