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Understanding Your Balance Sheet

Tuesday, November 01, 2011

Understanding Your Balance Sheet
By Tony Argiz, CPA/ABV/CFF, ASA, CVA, CFE (targiz@mbafcpa.com) and Marc S. Dickler, CPA (mdickler@mbafcpa.com)
published in Professional Auto News

Today, dealerships are still facing significant economic roadblocks on the path to success and profits. To overcome these challenges, careful budgeting and overall good planning are absolutely vital.

Do you know what all those numbers on your dealership's balance sheet really mean? If not, then you could be at a competitive disadvantage. Analyzed thoroughly, the balance sheet can be the key to diagnosing the financial and operational health of your business.

While it may be the job of the accounting department to prepare a dealership's monthly financial statement, it is ultimately the responsibility of the owner to review the balance sheet and understand its implications. The following is a review of the key asset elements of a balance sheet and what they can tell you about your operation, as well as some of the best practices for optimizing profits.

Contracts In Transit

With very few exceptions, the number of end-of-month contracts in transit (CIT) should represent no more than five days worth of vehicle sales. For example, if a dealership averages $4.5 million in retail vehicle sales per month, the daily average (for a 30-day month) would be $150,000. Thus, in this particular case, the CIT amount should be no greater than approximately $750,000.

If your CIT number is equal to or greater than 25 percent of your monthly sales, it probably means that your system for processing contracts is inefficient, or your sales department is "borrowing" from the next month's sales to artificially increase the current sales. This last practice, if left unchecked, can lead to a distorted financial picture of your dealership, and defeats the purpose of proper monthly cut-offs.

As for slow processing of contracts, some of our clients have managed to reduce the processing time to as little as 24 to 48 hours. In many cases, this was done by taking on more of the responsibilities that can delay a final sale, such as drafting tags at the dealership rather than having it done by an outside agency.

Of course, as with most rules, there is an exception. If you had a major sale at the end of the previous month, you can expect to have a greater percentage of dollars, as high as 35 percent, in your CIT.

Used Vehicle Inventory

The largest asset of any dealership is going to be your inventory. In the case of used vehicles, if you have more than a 30-day supply on the floor, you could be developing a serious aging problem. As with any retail operator, you should think of floor space as a commodity, which is limited. Therefore, the space should be devoted to items that are likely to move quickly.

Used vehicles continue to be in short supply today. As a result, the average cost of used vehicles continues to climb. Average prices in just one year increased by approximately 10%. To drive your used vehicle sales in this environment, you need to manage your inventory mix. Here are a few helpful tips:

• For used vehicles that have been in stock more than 60 days, discount the cost by 10 to 15 percent and charge it to operations.
• After 90 days, write off 30 percent of the original cost, or offer other special incentives to force the sale.
• Low-end used cars in the $11,000 to $15,000 range will move faster than those above $20,000. Smaller models are also more popular.
• Rather than relying on display ads, offer incentives to salespeople.
• Establish and market a certified vehicle programs to spur used car sales.

New Car Inventory

In general, there is more flexibility in the recommended size of a new car inventory because you are totally leveraged. However, you continue to pay interest on your floorplan, so we recommend that dealerships maintain an inventory range of 45 to 60 days for domestic vehicles and 35 to 50 days for imports.

Why is this important? Consider the following. With new cars averaging $30,000 and an interest rate of five percent, the average new car costs a dealership $4 per day to keep in stock. For a dealer to carry 90 cars for an entire month, the total cost will be $11,000. This figure is subtracted directly from your bottom line.

Parts Inventory

Under no circumstances should a dealership carry more than a 60 day supply of parts. Ideally, a dealership will turn the parts ordering function over to a computer program that is directly linked with the factory. The program would then evaluate demand and sales for each part item, apply a formula, and automatically order more parts when the stock dips below unacceptable levels. Naturally, the guiding formula will need to be reviewed quarterly and updated if necessary.

Also, to avoid parts inventory problems, reconcile your pad with your general ledger on a monthly basis, and establish a system whereby your parts manager can get rid of parts that have been in stock for more than six months. At best, parts older than 200 days should only account for five percent of your total inventory.

Service and Parts Receivables

At the very most, receivables should represent no more than 30 days worth of parts sales. Ideally, this number should hover around 22 - 26 days. Anything over 30 days should lead you to the conclusion that you have several tardy accounts. Examine this amount carefully every month. If the total seems high, look for an explanation. In addition, all parts and service customers with accounts should be put on a COD basis if their balance is older than 45 days.

In addition to the key assets we've reviewed above, the following are some additional suggestions you'll want to consider for improving profits:

• Warranty receivables should represent between 15 and 30 days worth of billings to the factory. A higher amount means there could be write-offs.
• Finance portion from contracts should be no greater than 20 days worth of financing contracts. Anything more means that your contracts are getting stuck in the financing office.
• Prepaid expenses should be wiped clear every month and should rarely be allowed to carry over from one month to the next. The determining factor of whether to carry a prepaid expense over should be its benefit to future periods.
• Your dealership's cash account should be reconciled monthly with your bank statement, and all dealers should independently review their bank statements monthly.

By fully understanding the nuances of your dealership's balance sheet, you can improve your ability to identify operational abnormalities, detect fraud and most importantly, improve your bottom line. And that means better chances for real success in the months and years ahead.

(Tony Argiz, CPA/ABV/CFF, ASA, CVA, CFE is the Chairman and CEO of Morrison, Brown, Argiz & Farra, LLC. Marc S. Dickler, CPA, is a principal in the Audit Department at MBAF, and is the principal-in-charge of the firm's Baltimore office. He also heads the Automotive Dealerships Audit Practice. If you would like a complimentary initial consultation or wish to discuss the general operations of your dealership, please contact Tony at targiz@mbafcpa.com or Marc at mdickler@mbafcpa.com, or call 1-800-239-1474. MBAF is home to one of the country's largest auto dealership practices, and is independently ranked as the largest Florida-based public accounting and consulting firm in the state. For fifteen years, the firm has been consistently ranked Best of the Best as one of the top 25 performing firms in the country. For more information, visit www.mbafcpa.com).

Printed with the permission of Professional Auto News