Tesla is an interesting example of how a company can move from substantial financial losses to a profitable business capable of generating cash from its own operations.
Throughout much of the 2010s, Tesla reported net losses and often had negative cash flows from operating activities. The company invested heavily in developing electric vehicles and technology and in building new factories. To finance these investments and continue operating, Tesla relied on borrowing and issuing shares.
As production and sales increased, the company's financial position began to improve. Tesla was able to generate positive cash flows and later achieve an annual net profit. However, its financial development has not always been steady, as competition, production costs, and price changes have affected the company's profitability.
How did higher production affect Tesla's profitability?
Open the income statement and examine how the gross margin changed over the years.
The gross margin shows the percentage of revenue that remains after the cost of sales is deducted. As Tesla increased vehicle production, it was able to spread some of its fixed costs across a larger number of vehicles and improve production efficiency. This had a positive effect on the gross margin during several years.
Later, however, competition in the electric vehicle market intensified, and Tesla reduced the prices of some models to encourage sales. These reductions, together with other cost and production factors, put pressure on profit margins.
This development teaches us that higher sales do not necessarily mean higher profitability. A company can sell more products while earning less from each product sold.
Why did Tesla need so much cash?
To understand this, examine the cash flow statement, particularly operating and investing activities.
During its years of expansion, Tesla spent billions of dollars on building factories, purchasing machinery and equipment, and developing production capacity. These capital expenditures, known as Capital Expenditures (CapEx), contributed to negative cash flows from investing activities.
It is important to understand that a negative cash flow from investing activities is not necessarily a sign of poor performance. It may indicate that the company is investing to expand its capacity and operations in the future.
A particularly important measure is free cash flow (Free Cash Flow – FCF), which is calculated by subtracting capital expenditures from net cash flow from operating activities.
FCF = Operating cash flow (OCF) − Capital expenditures (CapEx)
When FCF is negative, the company spends more cash on capital investments than it generates from operating activities. When FCF is positive, the company has cash remaining after covering these investments, which it can use for other financial needs.