How does Tesla not go bankrupt just at loss?
Updated: Nov 28, 2022
By July 2020, Tesla had become the world's highest-market carmaker, even though it produced far fewer cars than rivals such as Toyota, GM and Ford. But in addition to producing fewer cars, Tesla has also lost money year after year since its founding in 2007. In 2018 and 2019 for example, Tesla reported losses of nearly $1B.
Well, wait, how can a company that never made money continue to exist? In this post, we will explain how a company's cash flow works and clarify how a company that makes losses every year does not go bankrupt and is able to continue operating.
Definition of Bankruptcy
Although Tesla has annual losses, the key is that Tesla never runs out of cash.
Typically, a profitable company increases the size of its cash on hand. A loss-making company usually needs to withdraw money from its cash to finance operations.
But in practice, what really determines if a company goes bankrupt is not the losses. It is the amount of cash on hand. And a company can never, but never run out of cash. In the end, as the saying goes, “cash is king”.
In fact, if you look at how much cash Tesla has in cash, that figure has only increased in recent years! Tesla reported cash availability of US$8.6B in mid-2020, in the midst of the covid-19 pandemic. How does a company with constant losses manage to keep increasing the availability of cash?
The answer is: there are different sources of cash in a company:
Cash flow from operating activities
Cash flow from investing activities
Cash flow from financing activities
All of these sources are described in the report that every company traded on a stock exchange must publish to the market each quarter. The cash flow statement is the report where you can actually see the level of health of a company. Still, it's the report least watched and understood by most novice investors. Each of these 3 sources can generate or withdraw money from the company's cash, depending on the business situation.
1. Cash Flow from Operating Activities
Starting with the first and most intuitive of all: business operations
This is the money produced by the company's own business, resulting from receiving payments in exchange for the product or service sold, minus all expenses associated with the business, such as payment of salaries, materials, suppliers, among others. In a mature and profitable business, this is often the main source of cash flow. In 2019, Microsoft, for example, generated $52B of cash from operating activities.
This has not been the case with Tesla for many years.
Until 2017, Tesla's operating activities were still negative. Although Tesla made money for every car sold, by including all other expenses like research and development, administrative expenses, charging station maintenance, marketing, and so on, the total cash flow from operating activities turned into negative. In other words, Tesla spent more money than it received to operate the business.
In the last 2 years, Elon Musk managed to reverse the situation a little. Although Tesla still has book losses, operating cash flow is already positive. In 2019, Tesla reported a $2B cash increase as a result of its operating activities. The main reason for this is that a series of depreciation and amortization costs have already been paid in the past but, according to accounting rules, they need to be divided over the years when reported in the income statement. Thus, these costs still impact the company's profit result, causing losses. But since the money has been spent in the past, it no longer impacts cash flow. We'll still make a new post explaining better how depreciation and amortization costs work.
In summary, despite the losses, today Tesla's business already generates more money from the company's cash withdrawal.
2. Cash Flow from Investment Activities
These are cash movements related to the purchase and sale of assets such as factories and offices, investment instruments such as stocks, or cash loans. This has been and continues to be Tesla's main consumer of capital over the past few years for a very obvious reason: Gigafactories. Tesla has built some of the biggest factories in the world and, as a result, has spent a huge amount of money on this type of investment. It's been over $9B over the past 5 years!
3. Cash Flow from Financing Activities
This is the source that truly allowed Tesla to never run out of money. Financing activities represent money received through loans or investors, in addition to dividend payments, share buybacks or loan payments.
When the company receives investments or loans, this is a cash-generating source. When the company needs to pay interest or dividends, this source consumes money from the company's cash.
What really kept Tesla alive for a long time was the borrowing and selling of Tesla's own shares to investors, raising capital. In terms of loans, today Tesla has a total of US$14B still to be paid, which represents 67% of revenue. It may sound like a lot, but when compared to other companies in the sector, Tesla is relatively in line with competitors.
In addition, Tesla also raised money through the issuance of shares which are then sold to investors through the stock exchange. An example of this are IPOs (initial public offering of shares), when companies sell their shares for the first time on the market.
Tesla made its IPO in 2010, raising $226M in the process. But even after the IPO, the company issued new shares, selling them on the stock exchange and diluting shareholders. As Tesla's share price is often quite high, Tesla is always able to raise relevant amounts of money through this mechanism so that investors are very little diluted. Practically free money as this money does not need to be paid back and the company does not pay dividends.
Attractiveness of an investment
However, keeping a loss-making company alive in this way is not so simple. It is enough for banks or investors to stop trusting the company and stop investing or lending money for the company to quickly spend all its remaining cash and go bankrupt.
For a bank that lends money, for example, 2 factors matter: the probability of the company paying back the loan received and the interest rates charged.
What usually dictates the attractiveness of this are ratings companies such as Standard & Poors and Moodys. Companies and other investment instruments are classified according to their level of risk, ranging from the lowest to the highest possible, usually applied to US treasury bonds, an investment theoretically considered risk-free given that the government only needs to print more money to pay off the debt. The more risky the company, the higher the interest rate charged by banks or the smaller the number of banks willing to lend money.
Today Tesla's rating is B+, still considered a speculative investment, far from companies like Apple, Microsoft, Google or even some competitors (Apple and Google AA+, Toyota A+, Ford BB+). Much to her still losing money.
Despite this, Tesla manages to finance itself because institutions and investors believe that in the future the company will no longer be loss-making and will start generating positive profits and cash flow.
And Tesla is almost there. The company's losses have already been decreasing, with positive results in some quarters. Also, the cash flow from operating activities was positive in 2018 and 2019, that is, the business itself generated more money than it consumed, which allows Tesla to reduce the amount of loans or share sales in order to keep capitalized.
Over time, Tesla should continue to reduce the need for loans and increase cash generation from its own business, growing in a more sustainable manner. It is precisely these expectations that have caused stock prices to soar. Elon Musk has finally managed to prove that Tesla can become a healthy and profitable company.
Like Tesla, this is exactly how startups like Nubank, Uber, Airbnb and others remain in their first years of operation. While operating activities are not able to sustain the business, these companies rely heavily on loans and investors to keep growing. As a result, one of the main jobs of a CEO of a startup is precisely to be a great seller of the dream of a great future for the company. The more capable the CEO is, the more easily he can raise money and on better terms, such as better interest rates or at a higher price per share, less diluting the shareholders.
Going back to the 3 sources of cash - a well-managed business needs to balance these 3 sources. A company that consistently loses money operationally and relies solely on financing activities to sustain itself is doomed to fail if it fails to turn around business results. A company that generates a lot of money through its operations but does not have great ideas or projects to invest in its growth, on the other hand, will consume cash by paying dividends. This isn't great either as it means the company doesn't know what to do with the money it earns and must remain stagnant.
Finally, despite more than a decade of constant losses, Elon Musk's incredible ability to sell Tesla's big dream to investors and financial institutions has meant that Tesla has always been capitalized. The money raised was fundamental to operationalize the grand strategy of mass producing electric vehicles, which will now allow Tesla to be able to turn its sales into profit and, above all, into positive operating cash flow.