Planning for Profit and Value

Date October 25, 2019
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Whether or not you plan to sell your dealership, your business plan should be designed to increase its value. The industry is riddled with unintended consequences. This refers to the implementation of business practices that might seem smart at the time, perhaps have worked for other dealers, and might even have been suggested or imposed on you by a manufacturer, but that in the end have actually decreased value. Even some of what are generally considered key profitability indicators, like fixed absorption or new technology, can negatively impact value if they are not correctly applied and administered.

Some of the key drivers of value that should be addressed in the business plan:

  • Compensation
  • Market Share
  • Customer Satisfaction
  • Location
  • Real Estate
  • Operational Profitability
  • Succession Planning

Compensation
Some dealers find it surprising that in certain dealerships someone other than the dealer principal is the most highly-compensated employee. This tends to indicate the dealer has handed over control to a successor, who may be a family member. However, is even more significant (in terms of perceived value) if the dealership’s general manager, the highest paid employee, is not a family member. Dealerships are much more valuable if the infrastructure is in place to continue its operating profitability if the owner is no longer there.

Compensation can be a gauge of performance. High performers tend to be highly compensated. Below average wages usually indicate a staff of poor performers, high turnover, and an overall weak operation.

Compensation is affected by various factors, such as cost of living in the area, and those factors must be considered when examining a dealership compensation program. We recommend a formula based on gross profit per employee, or broken down further by department per employee. Still, the analysis is subjective. Some dealers do quite well by overpaying employees. Being known for overpaying attracts the best of breed of dealership employees. One approach to determining appropriate compensation is to look at what it would cost to replace someone in a particular position. Decisions on compensation should be done with an eye toward sustainability.

Market Share
Manufacturers are particularly concerned about market share – and holding dealers accountable. They will pull a franchise for declining market share … or, at least, put significant pressure on the dealer to increase unit sales. Dealers looking to purchase a store will consider market share in their valuation. Minimally, maintaining market share effectiveness has to drive part of any business plan.

Customer Satisfaction
The internet has changed our game. Young buyers look at online reviews to decide where to shop, and they are moved more by negative than positive reviews. Prior to the internet, a customer with good experience would spread the information to an average of 17 people, while an average of 70 people would hear about a bad experience. How far and fast does it spread now? Negative reviews must be kept to a minimum; the customer’s impression is reality. Negative reviews will kill you, no matter how much advertising you do.

Location
Locations change in desirability, and therefore value, over time. If you can’t move, it is critical to stay up with changing trends in your market, and adapt. It might even mean changing the brands you represent. Many dealers are doing well in less than desirable areas by carrying the right products or catering to the unique needs of the buyers in their market.

Real Estate
Whether you own your property and are renting it to your dealership or renting the property from a third party, it is important to pay the appropriate rent. Currently, dealership facilities are renting for about 6 to 8 percent of the current appraised value on a triple-net basis. If you own and charge your dealership too much or too little, the incorrect expense could mask other profitability issues. On the other hand, peers looking to buy will want to ensure an appropriate return on the dollars they invest in the real estate.

Overbuilt facilities will detract from value because no one wants unproductive real estate. You could sell some of the excess ground; but, you cannot sell space inside your excessively large facility. Your manufacturer might encourage you to expand or upgrade your facility, but you have to determine if that will improve dealership value or profits. Building the Taj Mahal of dealerships is rarely a good business decision.

Operational Profitability
The new super-group dealerships are centralizing departments like Human Resources and Information Technology to generate considerable savings. It does not make sense to centralize operations if you have very few locations or if the locations are distant from each other. More important is hiring competent staff. We generally look to reduce departmental head count by about 40 percent before centralizing office operations.

Succession Planning
How you plan for succession will have an enormous impact on value. You’re going to be replaced at some point. Have you identified your successor? Have you established a timeline? Communication is key. Often the person the dealer has in mind as successor has not been told or does not have an idea of when he or she will take over. The person you have identified might not want the job, even if it’s a family member. We advise dealers to start the process about five years in advance of their planned retirement. That way, if there is a problem with the identified person, there is time to restart the selection process. Succession planning should be part of your strategic planning and an essential element in your business plan.

Note: We are happy to send you a copy of our series of articles titled, “Ten Steps to Effective Succession Planning.” Just call us at 317-886-1624 or email Valerie Ramun at VRamun@hbkcpa.com.

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Inventory Efficiency: Do the Math

Date October 9, 2019
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Parts managers are using complex mathematical formulas to compute their optimal inventory quantities these days – though they might not be aware of it. Your DMS system is thinking through the process using calculus to create formulas and cost curves with the ultimate goal of minimizing the cost of ordering, stocking and holding the parts inventory.

Generally, the more of a part you order, the less expensive it is – not only is the part price reduced, but so are other costs, like transportation and labor. On the other hand, ordering in quantities that don’t sell in a timely manner, even to the point of obsolescence, raises costs, not just for parts that don’t get sold but for “frozen capital.” In essence, this leaves money sitting on the parts shelf that could be used in more productive ways. In the language of your DMS system, where the part cost and carrying cost curves meet is theoretically the optimal order quantity.

Of course, running the calculus is the computer software’s job, not the parts manager’s. But even without a computerized formula it’s important to think about where these curves meet, and what tools you have available to ensure you are inventorying intelligently.

Inventory and Turn Rates
Optimally parts inventories are going to turn four to six times a year. Accordingly, a dealership should retain 60 to 90 days of parts on hand. To compute your dealership’s turn rate, take your cost of goods sold for parts (sales minus gross profit) and divide that number by the cost of the parts inventory you have on hand. Then use your turn rate to determine how many days supply you have in inventory.

An example calculation:
The factors:
Parts sales for a year = $3 million
Gross profit on those sales = $1 million
Current parts inventory = $380,000

The calculation:
Cost of goods sold ($3 million minus $1 million) = $2 million
Parts turn rate ($2 million divided by $380,000) = 5.26
Current supply ($380,000 divided by $166,670 [$2 million divided by 12 months]) = 2.27 months or 68 days

Dealerships will necessarily find some inventory stale and not turning, while other parts are turning quickly. The only way to counteract the losses associated with the slow moving or obsolete parts might be moving the fast moving parts even faster. Understanding which parts are slowing the turn rate will help the dealer make adjustments to minimize losses.

So yes, there is real value in the math you learned in middle school that you thought you’d never use. Math makes for better parts management, a better return on your investment.

Three Key Reports
There are several DMS reports that can help to make your parts operation more efficient, but there are three that are essential to having the right parts on the shelves at the right time.

  1. Emergency Purchase Report. Buying from another dealer or suppliers as needed decreases net profit in both parts and service departments through higher initial prices, transportation costs, and service department downtime. Recording emergency purchases in your DMS as they occur and reviewing them regularly –at least weekly– will help you adjust your inventory accordingly.
  2. Lost Sales Report. If a sale is lost because a part is not in stock, it should be properly reported. A lost sale is defined as a sale that it is reasonable to assume would have been made if the part was on hand.
  3. Service Department Fill Rate Report. A weekly fill rate report gives parts managers a clear look at what’s going on in the shop. To correct fill rate inefficiencies, run the report by part number and same-day fill rate.

Take the following into consideration when reviewing these reports:

  • If the unit requiring the part is a new model – and could this be a trend?
  • Is the required part essential to operation of the unit?
  • Is an emergency purchase or a lost sale recorded for a part used in routine maintenance?
  • Does the parts locator section in your DMS indicate that other dealers are stocking a part you don’t stock?
  • Does the factory maintain a large quantity of a particular part?
  • Does my inventory reflect the population of models in my area?

Doing the math and reviewing your reports on a weekly basis will make for happier customers, more efficient employees and, by thawing out your frozen capital, a better bottom line.

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IRS Issues Regulations Favorable to Dealers

Date September 16, 2019
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On Friday, September 13, 2019 the IRS issued proposed regulations that clarify bonus depreciation and interest expense for dealerships with floor plan financing. To the extent that overall interest expense, including floorplan interest, is below 30% of adjusted taxable income, a dealership will be eligible to take 100% bonus depreciation. Further, eligibility to take bonus depreciation is determined on an annual basis. Therefore, even if a dealership has to use the floor plan exception one year in order to deduct all of its interest expense (thereby losing the ability to take bonus depreciation in that year), it may still be eligible to take bonus depreciation in subsequent years if overall interest expense falls below 30% of adjusted taxable income in that given year. This is great news for dealers who may have thought that bonus depreciation was lost forever.

When issued, the Tax Cuts and Jobs Act of 2017 ushered in the most comprehensive and sweeping tax reform since The Tax Reform Act of 1986. Among the many changes that resulted was an interest expense limitation equal to 30% of adjusted taxable income. Another notable outcome was the increase to bonus depreciation. Prior to the 2017 act, bonus depreciation was to drop to 40% of the cost basis of the asset. The 2017 act increased the rate to 100% for assets placed in service from September 27, 2017 to December 31, 2022.

What was the impact of these changes on dealerships? Rex Collins, HBK CPAs & Consultants (HBK) Dealership Industry Group Principal, had an audience with the House Ways and Means Committee during the development of the bill proposals. As a result of his testimony, the House version of the bill included language that allowed dealerships with floor plan financing to deduct all floor plan related interest expense, even if that expense ultimately exceeded 30% of adjusted taxable income. However, dealerships would also not be able to benefit from 100% bonus expensing. Originally, the law as passed was interpreted as allowing a full deduction of floor plan interest while excluding a dealership from 100% bonus depreciation.

Subsequently, the Joint Committee on Taxation issued a Blue Book interpretation of the interaction between floor plan interest expense and bonus depreciation that was much more favorable to dealerships. Essentially, it suggested that if interest expense including floor plan interest was less than 30% of adjusted taxable income, the dealership may be eligible for bonus depreciation expensing. However, the interpretation also held that once a dealership used the floor plan exception, the dealership would not be eligible to use bonus depreciation in subsequent years.

Friday’s announcement by the IRS of the new final and proposed regulations clarifies the conflicting language in the act and the Blue Book interpretation and is welcomed good news for dealers with floor plan financing.

Contact the HBK Dealership Industry Group today to discuss planning opportunities related to bonus depreciation as well as many other items that impact your dealership.

Rex Collins is a Principal at HBK CPAs & Consultants. He directs HBK’s Dealership Industry Group, which provides tax, accounting, transactional and operational consulting exclusively to dealers. Rex can be reached by email at rcollins@hbkcpa.com, or by phone at 317-504-7900.

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