Buy here pay here sales and collections can bring special problems to your accounting department. Having a related finance company (RFC) can also complicate your accounting. There are special relationships between various accounts on each company and between the companies.
When we review financial statements for our clients and prospective clients, we try to stand back and look at them for reasonableness. This includes not only the income statement but also the balance sheet accounts.
One way to review your income statements is to run your report with the months in the current year side by side. This makes it easier to compare missing expenses or spot expenses which are too high. Your income accounts can also be compared to see what trends are starting to appear, if any. Is your income trending up, or is it stagnant?
You should also prepare your income accounts by year side by side for the current year and at least the prior three to five years. This will show you your long-term trends. This report works well to prepare projections for the future and show you what it takes to get there. You should be able to easily see where you have been and insert your projection of where you want to be to find out what kind of change it is going to take to achieve your goals. You may find out there are various accounts which should have corresponding relationships with other income or expense accounts, but don’t.
When reviewing your balance sheet you can and should compare it the same way as your income statement. The balance sheet comparison will show you the changes in assets, liabilities and net worth on month-to-month and year-to-year bases. Your change in accounts will indicate where your cash flow is going. If your assets, other than cash, are increasing without a corresponding offset in a liability account, then your cash flow is going out. If your liabilities are increasing, it can be a sign of cash flow going in, as you are not spending it to pay your liabilities. This is a very simple way to look at cash flow. There are many other indicators of cash flow activity, but that is for another article.
On your RFC, we look for certain relationships of your notes receivable principal balance to unearned discount income and the allowance for doubtful account adjustments for GAAP financial statement presentations. Your unearned discount income on the balance sheet should be a percentage of your notes receivable. This percentage should be equal to the percentage of discount loss you have taken on the various pools of notes purchased from your dealership which are still in your current portfolio. The percentage may not and probably will not be exactly equal to the percentage you used when selling the notes.
There are various reasons for this odd unearned discount percentage and resulting account balance. One is you have used multiple discount percentages over the life of your current portfolio. Another can be some of the notes you purchased had to use a reduced discount percentage because the dealership is limited to a discount loss which can’t exceed the gross profit realized at time of sale. Normally one of your BHPH software reports should disclose the percentage for each note along with the outstanding principal balance. You can then find your different discount percentages.
You should review the accounts and activity which makes up your cost-of-goods-sold section on your dealership income statement. Separate selling-type expenses from your cost of goods sold so you can arrive at a correct gross profit percentage. We normally want to see a 45-percent to 50-percent average gross profit.
You should be checking your discount loss when selling the notes to the RFC to insure the loss doesn’t exceed the gross profit from the car deal. You can set up custom reports on your software to compare the discount loss to the gross profit at year end for year-to-date sales and make the necessary changes to the unearned discount income balance if needed.
One of the other items we look at is the gross leverage ratio of your outside third-party vendor debt used to finance your notes as compared to your current notes receivable principal balance. We would prefer to see your leverage ratio at 50 percent or less. This normally indicates a stronger and healthier balance sheet. In talking with many bankers, they prefer the 50-percent-or-lower percentage also. Their risk is much lower and they can normally offer a lower interest rate based upon their lending criteria.
We will next look at the amount of interest and discount income earned and the amount of repossession loss incurred. Normally your interest income should exceed your repossession losses. This will enable you to use your earned discount income (deferred gross profit from your dealership) to “pay” for your expenses and will still leave you with a substantial profit on the RFC. If your repossession losses exceed your interest income, you will normally be outside of the expected net income level you should be achieving for the RFC.
We normally prefer to see your gross repossession loss, ACV recoveries, recovery income after write-off and unearned discount income in separate general ledger accounts. This will enable you to see your true principal write-offs less any ACV recoveries and use this for your static pool calculations and comparisons. When the unearned discount income “not earned” on the write-off principal is recorded in the same account as the repossession loss, the true repossession loss is hidden.
Another thing we review is whether each company is paying its fair share of expenses to truly operate the business as if it were a “standalone” business and unrelated third-party company. There are many shared common expenses which should be constantly evaluated for correct allocation between the companies. Each company has certain expenses which are specific to its operations of either sales or collections.
A review of your monthly cash receipts for the amount of cash collected should be compared to your monthly cash outlays. Most of the time our dealers tell us they have no cash. They normally don’t, but only because they have outgrown their line of credit, have spent too much on inventory and maybe expanded to additional locations when they should have just maximized what they already had.
Some dealers sell off some of their notes to rectify this situation. When they do so, they are normally selling their most mature and best performing notes rather than the most current and risky ones. If you are selling notes to stay alive, you should really analyze whether you are better off to slow your sales and stay within your financial boundaries. You will be amazed if you slow up the purchasing of vehicles just a little, how much better your cash flow may be and how you can reduce your debt leverage ratio.
Vol. 8, Issue 10