A financial expert takes a look at dealership financial statements and offers insights into what dealers might be missing.
My profession is an interesting one.
It’s often misunderstood and commonly discounted in the automotive industry. In a world of exotic cars and cutting-edge technology, most people choose not to focus on their financial health. But it’s important. Extremely important!
And in the long run, it will separate the dealers that lead the pack from those that will fade away into the sunset.
Although I’m a professional accountant by trade, I spend little time thinking about debits and credits. Instead, I focus on business strategy and growth, albeit from a different perspective. I spend time understanding the business in front of me, analyzing entrepreneurial opportunities and recommending big picture alternatives. That’s it, that’s my job.
To perform my duties, I require one simple and comprehensive document: your financial statement. As a senior financial executive, and faculty member at Georgian College’s Automotive Business School of Canada, I often get asked: “What is the most important number on my financial statement? What should I be looking at? What ratios are important?” I will summarize my top three:
Contracts in Transit
To me, this is the most important number on the financial statement. The speed in which you convert contracts into cash is the key success factor for any dealership.
Let’s call this “level one” importance. Then, your ability to use this cash to grow your business is “level two.” Good companies can perform “level one,” but only the great ones have mastered “level two.” (This is my adaptation of Jim Collins’ theory from his book Good to Great.)
Metrics like “lease penetration” were born here and continue to be a key performance indicator for most organizations. Even more important than generating contracts is collecting them.
By definition, a contract in transit represents the amount owed to the dealership for finance contracts on vehicles sold. I think it’s much more than that. It’s really a measure of operational efficiency. As this number grows, it tells the story of a healthy variable operation—one that delivers units at a consistent pace and, more importantly, one that has structured the “right” type of deal.
As we know, variable operations hit their “sweet spot” when they convert customers into three-to-five year leases or financing arrangements. This provides dealers with reserve income, opportunities to repurchase used vehicles, service work, customer retention, and more.
Metrics like “lease penetration” were born here and continue to be a key performance indicator for most organizations. Even more important than generating contracts is collecting them. And here lies the secret weapon of most dealerships: an efficient business office.
This “ebb and flow” that recurs month after month summarizes a dealership’s primary revenue steam, leading dealers do this well—really well. Proper analysis of your contacts in transit will identify weakness in deal structure, volumes, deal flow, and funding delays.
The story of a healthy variable operation is told in this one simple account. Are you paying enough attention to it? Are you good? Or are you great?
Fixed absorption
Industry experts love this metric. Truthfully, so do I. It just makes sense. If a dealership can cover its expenses through fixed operations, then vehicle sales will generate pure profits. It’s a perfect system. And when achieved, it will always lead to a financially healthy business. It’s perfect arbitrage!
While the goal is 100 per cent absorption, industry averages range from 60 per cent to 65 per cent. Think about it, as OEMs require newer, bigger, and more state-of-the-art buildings, a dealer’s ability to cover these carrying costs becomes more impossible to achieve. Therein lies the paradox of the retail automotive ecosystem. So how can dealers survive in today’s environment? It’s the same question I ask myself every day.
Independently, the absorption rate is a beautiful KPI. It measures the efficiency and effectiveness of a dealership’s fixed operations and summarizes its ability to manage expenses all in one metric. It’s a great way to identify a successful company. The challenge today is improving it.
In today’s environment, reducing costs is the only real way to improve your absorption rate. To make a big impact, you must cut big…really big. Let’s be honest, that’s no fun. No one likes reducing headcount, cutting technology, or slashing building maintenance—but there is no other way.
And that’s especially true during COVID. A dealer’s ability to increase fixed operations profit is limited, so they are forced to do the thing they hate most: reduce and restructure.
This financial measure has held the test of time, and it should. At its core, it is a financial analytic that summarizes a dealership’s ability to survive in difficult times. Dealers with a healthy bottom line also have a solid fixed absorption rate—these metrics are dependent. There’s no way around it.
Frozen capital
No one likes wasting resources. For business owners, it’s the equivalent of appendicitis. If left untreated, it will cause your demise. But if attended to quickly, you can live a long and healthy life.
By definition, frozen capital arises when money is tied up in non-income producing assets. In the dealership world, we typically see this in aged inventory and receivables. Both are equally problematic. The good news is, with better management, you can fix it.
Having the “right” amount of inventory is important to your financial success. Too much, and you’ll have resources sitting idle. Too little, and you’ll miss selling opportunities. Gone are the days of buying inventory based on “gut feel.” There is a better way. Use inventory turns and industry benchmarks to calculate optimal levels.
Your dealership representative is tasked to work with you on ordering inventory, both mix and quantity, and can help you offload units that aren’t moving. The key is to do something about it—it’s far too easy to do nothing, and waiting hurts. Frozen resources cost the dealership money. A lot of money. Do something about it!
You should take a similar focus on collecting aged receivables. It’s not the accounting department’s job to collect them—it’s everyone’s job. Parts managers can make phone calls too. Service managers can help with warranty receivables. This is a collective effort. The more you focus on releasing frozen resources, the better your financial health. It’s that simple.
To summarize, successful dealers leverage their financial knowledge and use their financial statements to understand the story behind their operations. It’s not complicated. It’s your competitive advantage. And when done correctly, it’s a tremendously efficient way to manage your business.
At the end of the day, you are running a multi-million dollar and often multi-geographical business, and you must make a profit to survive. Use the tools around you, think outside the box, and do it right. Read and understand the story being told on your financial statements.
