Maximizing Return on Equity (ROE) in the Automotive Industry: Why It Matters for CFOs and Dealer Principals

Written by étienne Demeules, CPA

In the automotive business, where staying competitive and profitable often depends on how well you manage your finances, one measure stands out: Return on Equity (ROE). For CFOs and dealer principals, understanding ROE is crucial. It’s a way to see how efficiently the company is using its investors’ money to make a profit.?

What Is Return on Equity (ROE)??

ROE tells you how efficiently a dealership, or any investment, is using the money invested by shareholders to make money. If your dealership has a strong ROE, it means you’re putting that capital to good use and growing the business. Think of ROE as a report card for financial efficiency.?

The formula for ROE is:?

ROE = Net Income / Shareholder’s Equity?

• Net Income: This is the profit left over after paying for things like taxes and costs of goods sold.?

• Shareholders' Equity: This is the total amount of money invested by shareholders, which you can find on your balance sheet.?

In the auto industry, an ROE of around 15% to 25% is typically considered healthy. A high ROE shows that the dealership is doing a good job generating returns for its investors.?

The Risk-Free Rate?

We’re going to take a little detour into the broader world of investing. Since you have options for your money, and operating businesses are an investment class, what is the baseline option? In other words, what is the least risky investment with a stable return that you could put that money into? That is known as “the risk-free rate”. A common proxy for the risk-free rate is 10 year US Treasury Bills.??

Currently, 10-year T-bills are offering a 4.43% annualized rate of return. In other words, you can take your money, do no work, take almost no risk, and get a 4.43% return each year for 10 years. If your investment (any investment, not just dealerships) is not at least a 3x multiple of that risk free rate, you may want to reconsider the risk and effort. Now, back to dealerships.?

Why Holding Too Much Cash Lowers ROE?

Having extra cash on hand might feel safe, especially when the market is uncertain, but there’s a downside. If too much cash is just sitting there, it’s not working for the business, and that can bring down your ROE.?

For example, say a dealership owner, Alex, decides to hold onto a significant cash reserve for a rainy day. While that’s understandable, that idle money could be invested back into the business—maybe through upgrading the showroom, improving the customer experience, or buying new technology to make operations smoother. If Alex’s dealership isn’t using this cash to generate revenue, the ROE will stay low, signaling that the business might not be making the best use of its resources.?

How to Improve ROE: Tips for CFOs and Dealer Principals?

Here are some practical steps to boost ROE:?

1.Reallocate Capital Wisely?

• Invest in growth: Put money into projects that will grow revenue, like adding new car models that are in demand or launching an online sales platform.?

• Avoid idle funds: If you’re sitting on excess cash, think about ways to invest it for a return. For example, upgrading facilities could attract more customers and increase sales.?

2.Use Debt Strategically?

• Smart use of debt: Let’s say you’re planning to expand your service department. Taking a manageable loan can boost growth without heavily relying on shareholder funds. This can lead to higher profits, which in turn improves ROE.?

• Keep an eye on debt levels: Make sure you don’t overextend your dealership. Too much debt can lead to financial stress, so finding the right balance is key.?

3.Improve Daily Operations?

• Cut unnecessary costs: Streamlining processes can make a big difference. For instance, adopting a more efficient inventory management system could lower storage costs and reduce waste.?

• Use technology: Automating routine tasks frees up time and can help employees focus on value-adding activities, improving overall profits.?

4.Focus on Inventory Management?

• Move inventory quickly: High turnover means cars aren’t sitting on the lot for too long, which frees up capital. For instance, a dealership that consistently aligns its stock with what’s in demand will avoid tying up money in slow-selling vehicles.?

• Avoid overstocking: Holding too many cars that don’t sell can hurt cash flow and ROE. Regularly reviewing sales trends helps maintain a balanced inventory.?

What This Means for Your Dealership?

ROE is more than just a number—it’s a way to measure how well your dealership is doing in creating value for its investors. By keeping an eye on ROE and taking steps to improve it, CFOs and dealer principles can show investors that their money is being used wisely and that the business is healthy.?

While holding cash can be comforting, it’s essential to put that money to work. The right balance between having enough for emergencies and investing for growth can make a significant difference in your ROE and, ultimately, your dealership’s future.?

In short, a solid ROE tells a story: that your dealership is efficient, profitable, and a smart place for investors to put their money. Keep that story strong by making sure your capital isn’t just safe but productive.?