What are the Best Metrics to Evaluate the Financial Health of Your Dealership?

Written by Véronique Boucher, M.Sc.????

When assessing the financial performance of a car dealership, it’s tempting to look for a single measure in the financial statements for an overview. However, finding an indicator that ticks all the boxes is not that straightforward.??

To accurately evaluate the financial health and long-term potential of a car dealership, one must analyze liquidity, solvency, profitability, and operational efficiency. Among these four indicators, profitability is often considered the best measure of a dealership's health. It's also valuable to consider the overall trend of these ratios and their improvement over time.?

Key Points to Remember  - There is no perfect method to determine the financial health of a dealership. These four indicators can highlight financial well-being but should be considered in combination.?        

Liquidity?

Liquidity is a key factor in assessing the basic financial health of a dealership. It represents the short-term viability of converting current assets and liabilities into cash. The cash a dealership has to manage its short-term obligations is crucial, because even if there is significant equity, if that equity isn’t converted into cash, it can create day-to-day problems. Before a dealership can thrive in the long term, it must first survive in the short term.?

KPIs in QUOTUS to Help Identify Your Liquidity:?

- Current Ratio: Measures the ability of the business to pay its short-term debts with its short-term assets.?

- Quick Ratio (Acid Test): A stricter measure of liquidity that excludes inventory from assets.?

- Cash Ratio: Focuses solely on cash and cash equivalents relative to short-term liabilities.?

The two most common measures of liquidity are the current ratio and the quick ratio. A quick ratio below 1.0 is often a warning sign, indicating that short-term liabilities exceed short-term assets. In such cases, several initiatives can be undertaken to improve the financial health of the dealership, including:?

• Strengthening Liquidity: To increase available cash, it’s important to collect payments from customers more quickly or negotiate longer payment terms with suppliers. For example, a car dealership might mean selling cars in stock faster to obtain cash sooner.?
• Reducing Expenses: Identify and cut non-essential expenses to free up cash. For instance, a dealership could analyze its advertising and promotional event expenses, reducing those that do not generate enough sales or leads, and reallocating those funds to more profitable initiatives.?
• Refinancing Debts: Negotiate with creditors to refinance or extend the due dates of short-term debts. Shopping around for lenders can save a lot of money in the long term.?
• Selling Assets: Consider selling non-essential assets to generate additional cash. For example, in a car dealership, this could mean selling demonstration vehicles or service cars that are no longer needed.?
• Monitoring and Planning: Implement rigorous cash flow monitoring and short-term planning to avoid liquidity issues. Choose a simple, fast, and effective tool for visualizing data, ensuring that its costs do not exceed its benefits. For example, a dealership could use a financial dashboard to track cash inflows and outflows in real time and anticipate future needs.??

Solvency??

Related to liquidity, solvency refers to a dealership's ability to meet its long-term obligations. Solvency ratios measure the dealership's long-term debt in relation to its assets or equity.?

KPIs in QUOTUS to Help Identify Your Solvency:?

?- Debt to Equity Ratio: Indicates the relative proportion of equity and debt used to finance the company's assets.?

- Total Liabilities: Represents the total amount of all financial obligations of the business.?

- Long Term Debt: Measures the amount of debt due in more than one year, impacting the company’s solvency.?

The debt-to-equity ratio is generally a strong indicator, as it measures investor confidence in the company. A lower ratio means that shareholders rather than creditors finance a greater portion of the company’s operations. A higher debt ratio isn’t necessarily bad as it allows for leverage; for instance, if a dealership finances the purchase of new vehicles through loans, a higher debt-to-equity ratio might boost sales and profits through leverage. However, if the automotive market slows down or sales do not materialize as expected, the debt burden could become problematic, reducing the dealership's ability to respond to financial challenges.?

?Therefore, it is crucial to maintain balance. For instance, a dealership might regularly reassess its sales forecasts and adjust its debt levels accordingly. A downward trend in the ratio over time would indicate that the dealership is strengthening its financial stability by relying more on equity rather than debt to finance its operations.?

Operational Efficiency?

The operational efficiency of a dealership is essential to its financial success. The operating margin, which measures the percentage of revenue remaining after covering operating costs, is a key indicator of a company's efficiency.?

KPIs in QUOTUS to Help Identify Your Operational Efficiency:?

?- Asset Turnover: Measures how effectively the company uses its assets to generate sales.?

- CP Sales Per RO: Measures the efficiency with which the company generates revenue per customer pay order.?

- Absorption Rate: Shows what proportion of the dealership's operating expenses is covered by the gross margin from fixed operations (parts, service, and body shop).?

It indicates how well the company management can control costs, optimize employee workloads to generate more revenue per hour worked, and create processes that minimize human intervention through technology. In a car dealership, effective management could mean optimizing technicians' work hours by maximizing the number of repairs performed per hour. For example, implementing a scheduling system that minimizes wait times and uses technology to automate administrative tasks can increase revenue without raising costs. Conversely, poor management that fails to control costs or leverage technology could shrink margins and jeopardize the dealership's viability, even if it has potential.?

Profitability?

While liquidity, solvency, and operational efficiency are all important factors to consider when evaluating a dealership, one of the most important elements remains the company's net profitability. Dealerships can survive for years without being profitable, relying on cash accumulated from past good profitability or from shareholder investment. But to survive long-term, a dealership must eventually achieve and maintain profitability.?

KPIs in QUOTUS to Help Identify Your Profitability:?

- Gross Profit as a % of Sales: Indicates the profitability of the company’s core operations.?

- EBITDAR % of Gross Profit: Measures earnings before interest, taxes, depreciation, amortization, and restructuring costs as a percentage of gross profit.?

- Net Profit or Loss Before Taxes: Represents the company’s profitability after deducting all expenses but before taxes.??

It is crucial to consider the net margin ratio, as a simple dollar figure for profit is insufficient to evaluate the dealership's financial health. For example, a dealership might generate a net profit of $500,000, but if that represents only a 1% net margin, it indicates vulnerability to any increase in costs or decline in sales. Such a situation could quickly lead to losses if market conditions turn unfavorable.?

In contrast, if the dealership shows a net margin of 5% or more, it has greater financial security, allowing it to reinvest in growth initiatives like expanding its vehicle inventory or improving customer service. Additionally, by analyzing the relationship between net margin and gross margin, the dealership can identify where it generates the most value—whether in vehicle sales, services, or parts—and adjust its strategy accordingly to maximize profits while maintaining good financial health.??

It’s interesting to analyze the net margin, particularly compared to industry peers, as a higher net margin indicates greater financial security and suggests that a dealership is in a better position to invest capital in growth and expansion.??

Conclusion??

In a car dealership, no single metric can solely identify the overall financial and operational health. For example, liquidity will tell you if the dealership can handle unexpected events, such as a sudden drop in sales or an increase in vehicle costs. Solvency will provide insight into the dealership's ability to repay long-term debts, such as loans taken to finance inventory purchases.??

Efficiency and profitability show how the dealership uses its resources to generate cash flows and profits. For instance, a dealership that effectively manages its operating costs while maximizing margins on vehicle and service sales is better positioned to thrive.?

However, a comprehensive assessment of a dealership’s financial stability requires an analysis that considers all these factors, tailored to the specifics of the business and the owner's goals. Ultimately, risk management and the risk tolerance vary from owner to owner, influencing strategic decisions and the long-term stability of the dealership.?

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