The average used auto dealership operates differently today than it did prior to 2008. Although margins can be healthier for “buy here pay here” dealers than for market rate dealers, accounting for these dealerships is complex. And cash flow is a constant concern. Dealers must balance inventory investment with collections. Yet, receivables alone don’t support healthy cash flow.
Receivables Rarely Keep Lights On for Auto Dealerships
There are two common scenarios that lead to buy here pay here dealership cash flow problems. Some dealers focus too much on buying vehicles, tying up their cash in inventory and experiencing a lag between car sales and collections. For the dealerships that try to balance inventory investment with receivables, it is difficult to sustain cash flow due to the car financing default ratios. Until they reach a certain size, dealers don’t collect enough in receivables alone to support regular investment in inventory, coverage of overhead or anything else.
If the dealership has common ownership in a related finance company (RFC), then there is the additional burden of ensuring the RFC has enough cash on hand to pay the dealership for the vehicle at the time of each financing transaction. In a previous article, we explained that RFCs allow dealerships to work with consumers who have little, no or bad credit. The consumer is able to finance a car through the RFC, separating the dealership from direct payment collections and other potential liability. The dealership collects cash up front. The RFC earns the income as it is earned from the car buyer’s payments.
Whether dealers are focused on inventory, receivables or expanding their transactions through RFCs, they will typically experience gaps in steady cash flow without some type of debt or equity contribution. A secure supply of cash flow requires regular management and vigilance as well as education around how to develop a healthy banking relationship. But there are appropriate ways to use debt (credit) to support cash flow while maintaining a healthy balance sheet.
Healthy Dealers Get Credit and Increase Cash Flow
It stands to reason that dealerships with good access to credit are considered healthy among other lenders or equity groups. They tend to have several things in common:
- Good location: Geography still matters in this industry, so lenders or investors will consider the physical location of a dealership, its longevity and the size of the city to support extension of credit.
- Good traffic: Traffic counts around the dealership will support projections of customer walk-ins, brand visibility and expectations for sales volume.
- Strong collections: The proof is in the numbers. Dealerships must show an emphasis on receivables directly as well as through an RFC. Unlike the IRS, however, lenders and investors will view the dealership and RFC as one entity when extending credit to one or the other.
- Well-performing loan portfolio: Although the industry standard is that just 10 percent of notes will survive the entire term, dealers must show that the majority of the portfolio is performing. Of course, recent notes are considered healthier than notes extending into year three or four when customer defaults and refinancing tend to occur.
- Healthy margins: Lenders and investors want to see a profit margin year over year in the dealership and the RFC.
If your dealership struggles with cash flow either intermittently or throughout the year, don’t let it hinder opportunities to grow. Talk to the team in Cornwell Jackson’s auto dealership practice group. They will help you understand the proper structure of financial statements to support proactive lender conversations.
Scott Bates is an assurance and business services partner for Cornwell Jackson and supports the firms auto dealership practice. His clients include small business owners for whom he directs a team that provides outsourced accounting solutions, assurance, tax compliance services, and strategic advice. If you would like to learn more about how this topic might affect your business, please email or call Scott Bates.
Originally published on February 7, 2016. Updated on February 20, 2018.
