In the December issue of BHPH Dealer, I spent a lot of time going over the need for a forecast (budget) in a BHPH operation.
A forecast is a financial road map for success in the business, giving you benchmarks or key performance indicators to judge your performance going forward.
The next step is to measure cash flow, because cash is what enables you to grow and prosper.
So what’s so hard about that? Count the cash in the “drawer” and add on the bank balance, right?
There are several possible sources of cash, the most obvious of which are investing your money in the dealership and down payments received on vehicle sales.
Other sources include payments received from your customers, proceeds from selling some portion of your portfolio of loans, borrowing money through a line of credit arrangement, reducing overhead and on and on.
The trick is managing those activities and others while continuing to meet your forecast of sales and profits.
If you’re keeping your financial records on a generally accepted accounting principles (GAAP) basis, there are many equity-building events that do not generate cash – at least not immediately.
For example, when you sell a vehicle, you receive the cash down payment, assuming the down payment is not deferred. But most of the sale is in a non-cash form: the retail installment sales contract.
It takes months of collecting payments for you to even recover the full cost of the vehicle sold, let alone generate any excess cash that finds its way into the business to support overhead and profit.
Some dealers tend to overstate their profit, saying they made a large profit on the sale of a vehicle by taking the sum of the payments over the life of the contract plus the down payment less the cost of the vehicle and calling the resulting figure gross profit.
That would be sort of the cash-on-cash profit if – and it’s a large if – you collect every payment.
In some cases, there’s a default that requires repossessing the vehicle, abruptly stopping the collection of payments absent collection of some or all of the deficiency.
Many dealers make no attempt to collect deficiency, effectively accepting the repossessed vehicle as payment in full.
So where was the profit?
Consider the following case:
A vehicle is purchased by your dealership and put into inventory at a total cost of $8,000. That vehicle is later sold to a customer for $15,000, with the customer making a down payment of $1,500.
The balance of $13,500 is financed using a RISC. Assume the RISC is financed for a term of 48 months at an interest rate of 18 percent, resulting in a monthly payment of $396.56.
Reaching break-even on the sold vehicle will require the purchaser to make 16 payments before you’ve recovered the cost of the vehicle.
Of course, you had to pay for the vehicle up front or when sold, so you’ve just experienced a negative cash event of $6,500 (the $8,000 cost less the down payment of $1,500).
So how do you cover that negative cash balance while you wait for the payment stream to replace your cash? And don’t forget, you’re selling several vehicles, so that negative cash flow seriously accelerates.
Without a solution, you won’t be in business for the long term.
A solution for the dealership is to also own a related finance company and sell the dealership’s auto loans to the RFC. Of course, that assumes you own an RFC that’s funded so it can purchase the loans.
Will “Uncle Harry” help you out with a loan to cover the negative cash flow? Those uncles are becoming harder to find. Or perhaps you have buried treasure you can raid for funds.
If you have neither of those resources, it’s time to think of alternatives, such as working with a bank to arrange a line of credit, contacting a third-party company to learn the range of products to monetize your portfolio or contacting a private funder, sometimes referred to as a senior lender.
Regardless of how the cash is obtained, it’s necessary to have cash to support the present level of business – and to support your dream of building the business to a higher level.
Regarding bank lines of credit, there are a few important prerequisites:
You can refer to my article in the December issue of BHPH Dealer for an example of those requirements.
Banks are also hampered by a regulatory environment that is prejudiced against nonprime loan support.
Convincing a bank that is not familiar with this business to grant a line of credit is difficult. There are banks large and small that have been successfully granting loans to used car dealers, but dealers must pass several hurdles to get one.
Beside filing liens on your business assets, it’s common for banks to require your personal guarantee on the loan.
The good news is while those loans are very difficult to obtain, the interest rate will more likely be favorable with banks, compared to other alternatives.
You can also obtain a line of credit from a nonbank company that serves as a funding source for Buy Here-Pay Here, independent and franchise dealerships.
One straightforward method is to pledge a portion of your portfolio of auto loans as collateral, with the funds provider advancing a substantial percentage of the collateral principal balance to you at the outset while you continue to receive customer payment cash flow over the life of the portfolio.
Your cost of funds is comparable to the rates being paid by banks and the largest auto finance companies – the funds are obtained from the same capital market channels the large companies use – but in this case, the loan transaction would be non-recourse to you and your dealership.
In addition to the funds received, some of those finance sources provide servicing, collections and more for you, allowing you to focus more of your efforts on sales.
You can also receive regular performance reports on the pledged portfolio, including delinquency and default levels, payments received and updates on the remaining balance.
Other companies are private lenders that function much like a finance company, typically borrowing money at some interest rate, then relending those funds at a higher interest rate to cover their cost of funds, administrative overhead and profit.
That model results in a higher cost of borrowing than borrowing from a bank, but the lender is often more willing to accommodate BHPH dealers.
Typically, the interest rate is relatively high and there can be other fees, such as boarding fees, early termination fees, etc., that need to be considered when calculating cash flow.
Regardless of where you borrow funds, you’ll need a forecast of cash flows that will look similar to this:
Dealership cash flow
Net Income after tax
Add sources of cash
Increase in floorplan borrowing
Increase in other liabilities
Increases in paid in capital
Subtract uses of cash
Increase in accounts receivable
Increase in inventory
Increase in fixed assets
Net change in cash
That cash flow presentation is for a dealership that is selling its loans to its related finance company and therefore shows no increase in receivables.
Also note that to support increasing sales, the floorplan (a source of cash) is increasing and inventory (a use of cash) is growing.
The presentation shows increases in ending cash every year, which, supported by the income statement and balance sheet, will show your projected success.
If the dealership holds its own receivables, an increase in loan accounts receivable delays the receipt of cash, resulting in negative cash flow. Receiving payments from customers, a source of cash flow, is based on the timing of customer payments.
Both inflows and outflows of cash need to be forecast so you can plan for cash needs from outside sources if needed.
Cash flow projections are challenging for non-accountants.
I recommend arranging professional accounting assistance for a financial presentation that will go to the bank or other provider of funding.
Jim Bass is the Senior Vice President of Strategic Relationships for Agora Data. He is a founder and past president of the National Automotive Finance Association and was the first recipient of the NAF’s Industry Excellence Award.
As Seen in BHPH Dealer Magazine – February 2022
© 2022, Agora Data, Inc. All rights reserved.