Anyone who paid attention to the financial crisis that struck in 2008 has certainly heard of the phrase “cash is king.” While many define "cash is king" to mean that a solid cash position in business represents a strong financial position, others believe it has a broader definition. And as any dealer knows, you need cash to fund your operations. For example, dollars are invested in inventory with the anticipation you will later convert that investment back into more cash than you started with. This sounds simple, right?
The challenges come with picking the right investments, having sound guidelines regarding the conversion cycle, and monitoring your return on investment (ROI). In the dealership industry we understand these as inventory turns, day’s supply, and gross profit. Dealers generally excel at watching grosses but too much focus here can lengthen the conversion cycle and ultimately lower your ROI. For example, purchasing a used vehicle for $18,000 and later selling it for a $2,500 gross profit sounds like a win. However, if the conversion cycle takes 90 days you could be missing an opportunity for a higher ROI. Taking the same $18,000 investment and converting it back to cash for half the gross profit mentioned above can lead to a higher ROI if the conversion cycle is shorted to 30 days ($1,250 x 3 = $3,750).
Grosses and inventory turns are only part of the overall equation. You need to pay attention to the efficiency of your process. Monitoring expenses plays a critical role which can be achieved with well-planned budgets and forecasts. This will help you quickly identify when expenses are increasing and allows you to pin point areas where corrections are needed. Watching key benchmarks like gross profit per employee and overall net income as a percentage of sales, will also help you monitor efficiencies.
Other areas to watch within cash management include reviewing receivables and managing debt. Typically we look for receivables to be collected within 30 days. However, offering a 1 to 2 percent discount to customers will often be enough incentive for them to pay earlier, therefore shortening your conversion cycle. Having debt can be a real asset to your company as long as it is done with the key points mentioned above in mind. The right level of debt will allow you to invest more funds and increase your ROI as long as inventory turns are kept in check. Idle funds or frozen capital, as it is often referred to, is a quick path toward lowering your profitability.
Knowing the right amount of cash reserve is also critical. Often this is thought of as a multiple of the dealership’s average monthly fixed expenses or a dealer’s set dollar amount. The problem is that during certain times of the year your cash reserve may need to be higher than others. For example, entering a period when sales are typically slower would warrant a higher reserve. Again, the use of an effective budget and forecast will help you identify these needs.
As demonstrated above, cash management is an involved process which calls upon many different skills and can involve several people within your dealership. Understanding where your biggest opportunities are is the first step. For further discussion or questions on how you can manage your cash more effectively contact your local Baker Tilly dealership team member.
For more information on this topic, or to learn how Baker Tilly dealership specialists can help, contact our team.