PALO ALTO, CALIF. – Over the weekend, Tesla opened pre-orders for it’s newly announced Model 3. With lines stacked outside dealerships, over 275,000 people put down $1,000 to be some of the first to receive the new electric car, priced at $35,000 for the base model. This represented $275M in cash for the company in down-payments, without having to take out a loan, sell stock, or as Kai Ryssdal of NPR’s Marketplace says, “it just fell in their lap.”
Of course, they now have to manufacture the cars. And there-in lies the problem as any freshman accounting student will tell you.
Don’t let anyone try to convince you that Tesla had $275M in weekend sales. It’s simply not true. That’s because pre-orders are not accounted as sales and future revenue isn’t accounted until it’s realized. Instead, it’s a liability on the balance sheet. For now at least. Not until the cars are actually produced and delivered and final payment is taken for the cars, can it be converted in accounting as “sales.”
What the $275M represents is a dual-party liability. Essentially, consumers who paid their deposit now have a $34,000 commitment to purchase or finance a Model 3, and Tesla has to commit to manufacturing 275,000 new cars. Granted, the agreement signed by customers allows both parties to back out at any moment. If Tesla can’t deliver, or if the consumer want’s out, both still have the ability to do so. But in theory, by receiving the $1k down-payment, Tesla is on the hook to create the product.
So, let’s take a look at the Tesla financial responsibility more closely.
Tesla has lauded it’s profit margins to be some of the highest in the industry (around 25% for past models). If the same financial model is in effect, the cost to make a new $35,000 MSRP Model 3 would run around $26, 500. Simply multiplying the manufacturing cost per car by the number committed ($26,500 x 275,000), you come out to a $7.2B liability – with the potential to receive $9.6B in sales when they’re delivered (an estimated profit of $2.4B).
That’s just the manufacturing price tag. The $275M is barely a drop in the bucket to pay the bill to make the cars. According to the company’s annual filings, it only has less than $3B in total current assets, including inventory, cash-on-hand and accounts receivables. Granted, some of the existing parts are probably not classified as inventory, as well as property assets, and other depreciating assets, but the GAAP (generally accepted accounting principles) accounting methods only counts finished products at the value of which they can be sold.
With that in mind, Tesla’s quarterly reports show that it doesn’t have the cash-on-hand to manufacture everything at once. Thus, where will the company find the other $4.2B?
There are two ways this could happen. First, Tesla could release new shares of stock, which would only dilute existing shareholder equity, but wouldn’t incur greater cash-related debt. The alternative is to use a rolling cash accrual, paying for things in batches to produce the cars as they can afford. Using that method, if Tesla could deliver 25,000 cars a month, they’d start making a profit on their manufacturing investment by the fifth month of production.
So, despite what you hear other places, Tesla currently didn’t have a big bump in sales – not just yet. It’s highly likely that when all of the cars are delivered, they’ll have a great profit to report to shareholders.
CORRECTION – A previous version of this story listed the sales price of the Model 3 at $30,000. It is actually $35,000, which adjusts Tesla’s debt to an even greater hole to dig out from.