Dealer Insights - May/June 2012 - The Balance Sheet — A Critical Management Tool
May 01, 2012
When your dealership’s financial statements arrive at your desk, is the income statement the first thing you examine? If so, you’re not alone — all business owners want to see that the money coming in is exceeding the money going out. But, although important, your income statement isn’t the best indicator of your dealership’s financial health. For that knowledge, you must turn to your balance sheet.
ASSESS YOUR EQUITY
Your balance sheet is a statement of what your dealership owns and what it owes at a particular point in time. The difference between your dealership’s assets and liabilities is its equity.
Your dealership has two financial goals: to increase its profitability and to increase its equity. Your balance sheet tells you how you’re doing on that latter goal — and a lot more.
REVIEW YOUR REPORT CARD
Your balance sheet is as much of a report card as your income statement is — it just grades you on different aspects of your performance. Let’s suppose that John Dealer, owner of fictitious import franchise Suburban Auto, reviews his annual balance sheet ending Dec. 31, 2011. John focuses on several specific indicators of his dealership’s financial condition:
|Net earnings (profit for the year)||$338,336|
equity (net worth)
|Total current assets||$3,652,590|
|Total current liabilities||$2,481,265|
From the data above, John can create some critical ratios for his dealership, such as its return on equity (ROE). These ratios become even more useful when you start comparing them over several years and pinpoint trends in improvements or declines. The value of the ratios increases further when you compare them to industry statistics.
DETERMINING YOUR ROE
To calculate ROE, take your net earnings and divide that amount by your equity at the beginning of the year. John can see that Suburban Auto had an ROE of 24.3%.
This would be a great return in the stock market, but for a dealership of John’s franchise, the benchmark for ROI on a strong-performing operation is around 32.0%. So there’s room for improvement.
CALCULATING YOUR DEBT-EQUITY RATIO
John also can calculate his dealership’s debt-equity ratio. He knows that too much debt can make his business vulnerable. For example, if his dealership is too leveraged in a downturned economy, it may be unable to withstand years of loss or raise money to reposition itself for better times.
To calculate the debt-equity ratio, take your total liabilities and divide them by your total equity at the end of the year. Suburban Auto’s debt-equity ratio is 1.43, which indicates that the dealership is running on an acceptable amount of debt — the lower the ratio the better — and isn’t too highly leveraged. The industry average for an import dealership is around 2.30.
FIGURING YOUR CURRENT RATIO
Another measure of safety and liquidity is the current ratio: current assets divided by current liabilities. “Current” assets are cash and assets that are expected to become cash within 12 months, and “current” liabilities are those that are due within 12 months. It’s crucial that your balance sheet show more items converting to cash than items requiring cash in the coming year, so your current ratio should be, at minimum, more than 1.0 — but higher is better.
Suburban Auto’s current ratio is 1.47, which indicates that it has more than enough assets to cover its short-term liabilities. The industry average is around 1.50. A lower ratio raises the concern that, if the dealership can’t get financing, it will be unable to meet its current debt obligations.
WHERE’S THE MONEY?
The big-picture insights your balance sheet can provide are invaluable in the long haul. But smaller puzzle pieces tell you where your dealership’s money is going now.
For example, the Used Vehicle Memo section of Suburban Auto’s balance sheet shows that 34 used, franchise-brand vehicles (valued at $508,444) and 52 used non-franchise-brand vehicles (valued at $688,036) were in inventory over 30 days, tying up nearly $1.2 million in cash.
Studies have shown that used vehicles over 30 days cost a dealership more than merely the interest it pays to the bank. Such costs include the wages of those who maintain the inactive vehicles’ appearance and operating condition and “spiffing” costs to your salespeople to move the older units. Plus, these slow movers typically produce a lower gross profit than would a fresh vehicle.
More missing money can be found under “Receivables Analysis.” Suburban Auto’s customers owed the dealership $93,654 in outstanding payments for vehicles and $18,085 in outstanding payments for service, body shop and parts invoices. That’s roughly $112,000 that could be working for the dealership, but isn’t.
WHAT’S THIS ABOUT?
The balance sheet also can raise questions. On its right side, Suburban Auto’s statement shows monthly profits ranging from a high of $45,549 in March to a low in-the-black figure of $16,488 in October and a loss of $3,502 in November. Why did the dealership lose money in that one month? John should already know the answer, but he might need to analyze the details to prevent a reoccurrence.
Sometimes the questions are tax-related. Under “Total Current Assets,” for instance, Suburban Auto values parts equipment at $240,682 and signage at $6,966. It appears that no depreciation is being taken on this equipment because there are no values in the corresponding “Accumulated Depreciation” section. Why aren’t these items being depreciated? This could signal missed opportunities for tax deductions.
A MONITORING DEVICE
The analysis of the balance sheet is only one of many tools at your disposal to manage your dealership. No one tool is going to be a complete solution. But, by using these tools in harmony, along with trending and industry benchmarks, you can keep a fine pulse on your dealership and know when trouble is beginning to brew.
SIDEBAR: WATCH OUT FOR ROUND NUMBERS
There are times when dealership owners need to question what they see on the balance sheet. On its year end statement, fictitious dealership Suburban Auto, for example, has an $11,000 line item for “nonautomotive inventory.” It isn’t clear what this item is, and the owner shouldn’t accept round-number entries without asking for an explanation from Accounting. Rounded numbers can be a red flag for unsubstantiated estimates, underreported expense or fraud.
To help catch errors and possible fraud, your dealership’s balance sheet accounts should be reconciled regularly. As an outside party, your CPA is in a good position to perform this service.
Dealer Insights - May/June 2012 Issue