Last year, hundreds of CPAs and financial professionals attended the AICPA & CIMA Dealership Conference to discuss critical information facing the current dealership industry. Top experts provided countless updates, best practices, and technical tools to help shift businesses into high gear. Below, we’ve highlighted helpful insights for you to consider in the new year.
Accounting and Audit Update
There were several new Accounting Standards Updates (ASUs) discussed, with a focus on ASU 2023-01: Leases (Topic 842) – Common Control Arrangements and ASU 2016-13: Financial Instruments—Credit Losses (Topic 326).
The two main issues addressed include:
- Legally enforceable terms and conditions: In order to reduce the cost and difficulty of applying ASC 842, Leases, a private company can elect to use the written terms of the lease to identify, classify, and account for a lease without having to determine if the terms are legally enforceable.
- Amortization period for leasehold improvements: Given the diversity in practice, this update provides for all leasehold improvements that are part of a common control leasing arrangement to be amortized over the useful life of the asset as long as the lessee maintains control.
The ASU for current expected credit losses, known as CECL, will likely have little impact on the typical dealership. The primary change that this standard introduces is that estimated losses must be considered over the entire life of the asset and be recorded upfront. Unless a dealership is carrying loan receivables on its balance sheet (such as a buy here, pay here), then this standard will potentially be insignificant to a dealership. However, dealerships and their respective CPAs will need to consider and document the impact from this standard.
The audit update primarily covered Statements on Auditing Standards (SAS) No. 145: Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement. This standard is meant to improve the risk assessment process and improve audit quality. The standard does not change the key concepts for determining audit risk, but it clarifies and enhances the auditor’s risk assessment, e.g., there will be a need to understand and evaluate individual components of an entity’s control environment, understand how business models integrate the use of IT, and implement the stand-back requirement to evaluate the completeness of key accounts.
Finally, there will be a new requirement to document the evaluation of whether controls have been implemented and the rationale for significant judgments for assessing risks of material misstatements.
Advancing Women: Lessons Learned from Other Industries
Monica Dalwadi, CPA, CIA, CFE, MBA, shared her career trajectory as a partner at Baker Tilly with attendees. As a child of Indian immigrants, she discussed how women and people of color often experience “prove it again bias,” shedding light on the constant scrutiny they receive and the need to repeatedly prove their competence in the professional sector.
Her story is universal: there are challenges to the advancement of women in the workplace regardless of industry.
One area to improve this industry inequity is for women to seek out a sponsor, an ally, or a champion. These roles differ from a mentor: a sponsor exemplifies someone who will speak on behalf of another when they are not present. An ally speaks up for another in the moment, and an ally provides a seat at the table and a safe space to share while still being an advocate. Another critical element is a role model—someone who will demonstrate how to successfully balance work and life.
Representation and encouragement matter in the workplace, and we all have the power and responsibility to do our part.
Ways to Maximize Dealership Fixed Operations
This session covered the importance of a dealership’s fixed operations and ways to improve profitability through technician and customer retention.
Fixed operations encompass the service, parts, and if applicable, collision repair operations of a dealership. Since fixed operations are a significant revenue stream for dealerships, it is imperative for dealerships to maximize these areas for optimal business.
A key component of this is the dealer’s absorption rate in measuring the financial performance of this department. Dealer absorption rate is the percentage of fixed dealership expenses covered by fixed operations' gross profit. An industry benchmark for dealerships is to aim for an absorption rate as close to 100% as possible.
In addition, the service department plays a significant role in fixed operations. Routine maintenance and repairs are completed by the service department, which builds customer trust and loyalty. Regular training and development for service staff can enhance their skills and productivity, raising the dealer absorption rate. Another invaluable aspect to this department is the service contract. Encouraging customers to invest in service contracts can provide them with peace of mind and the dealership with reliable income.
The parts department supports both the service and collision repair operations. Effective inventory management is necessary to ensure that the right parts are readily available, reducing downtime for repair jobs. It is also essential to maintain a balance between stocking parts for retail and wholesale customers. Proper forecasting and a well-organized parts department can help achieve this.
All dealership fixed operations require skilled technicians and employees for long-term success. The benefits of retaining technicians and employees not only reduce overall costs, but they also can lead to increased productivity and customer retention.
Furthermore, prioritizing customer retention has a significant impact on dealer profitability.
- Customer centricity: anticipating the customer’s wants and needs to provide a more complete customer experience.
- Improve processes by reinforcing behaviors: reward and recognize employees who meet or exceed their communicated expectations.
- Allowing dealership associates to take accountability: employees with defined responsibilities are more likely to hold themselves accountable.
- Teaching and reinforcing effective communication: the ability to distill non-technical information from the customer, convert it to technical information for the technician, and then convert it back for communicating the technician’s diagnosis and actions to the customers.
There is a strong correlation between customer retention and a dealership’s fixed absorption rate. If you have a 70% customer retention level, you can expect a 90%+ fixed absorption rate.
Benchmarking, Forecasting & Reporting
Forecasting and budgeting are important planning tools that can help companies more effectively manage cash flows, as well as provide more transparency around financial statements to the ownership group, OEM, and other third parties. Benchmarks and key performance indicators (KPIs) help to improve budget and forecasting accuracy.
KPIs are used to track performance against company goals, while benchmarks serve to compare company performance with its peers. Common KPIs for dealerships include new and pre-owned vehicle inventory and turnover rate, parts inventory and fill rate, and fixed absorption. Typical benchmarks for dealerships include hours per technician, effective labor rate, used retail units to total used sold units, and more.
As dealerships consider implementing these planning tools, it is important to keep the following top of mind:
Management and key stakeholders should identify and understand a company’s relevant KPIs and benchmarks.
- Select a comparable and appropriate peer group for the company.
- Ensure that the accounting records are accurate, including allocation of expenses.
- Involve and seek input from controllers, sales personnel, and service and parts team members.
Tax Updates for Non-Tax Practitioners
There are several recent tax updates relevant to the dealership industry that are top of mind for 2024.
Employee Retention Credit (ERC)
The IRS has issued several warnings in 2022 and 2023 on claiming credit via third-party promoters utilizing the supply chain provision. On September 14, 2023, the IRS issued an immediate stop to ERC processing. If a business has filed ERC claims and received money, ensure that amended income tax returns have been or will be filed for the proper periods. In addition, the business must have all documentation ready to demonstrate eligibility. If documentation is not available, consider holding all ERC money aside with a likely expectation of repayment.
8300 Reporting
The IRS has increased its number of audits for 8300 reporting. Key points include:
- The amount of cash to report is any sum over $10,000, e.g., bank drafts, credit union checks, money orders.
- Ensure that the most recent form is being used for reporting (the last updated version from the IRS is dated August 2014).
- Dealerships must obtain tax identification numbers (TINs) of the person(s) from whom they received the cash. If a TIN is not provided, include a statement with the incomplete filed form explaining why the TIN is not included.
- Beginning January 1, 2024, businesses that file 10 or more information returns must now electronically file instead of filing a paper return. To file electronically, a business must set up an account with the Financial Crimes Enforcement Network’s BSA E-Filing System.
Bonus Depreciation §168(k)
The IRS has allowed taxpayers to take additional depreciation for assets in service in a given tax year. Percentage of additional depreciation is phasing down annually as such:
- 2022: 100%
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
- 2027: 0%
Dealerships must not be subject to §163(j) interest limitation if they wish to claim additional depreciation under §168(k). The interest (including gross floorplan prior to netting with any manufacturer credits) cannot exceed 30% of the sum of taxable income and gross interest expense.
LIFO Relief
Many dealers experienced a large reduction in their LIFO inventory reserves in 2021, resulting in significant income tax liabilities. The U.S. Department of the Treasury has indicated support for LIFO relief, though no further action has been made.
Electric Vehicle Credits
For 2023, buyers of electric vehicles can potentially claim a federal income tax credit on the 1040, subject to several rules. In 2024, buyers will have an option to transfer credits to dealerships as funds for a down payment on a new or used car (eligible for the clean energy credit).
NADA and AIADA are working with the Treasury to ensure a streamlined repayment process is in place once the credit transferability occurs. Dealers must become a “registered dealer” with the IRS in accordance to proposed regulations.
Additional highlights on new EV guidance:
- The transfer of the credit is all-or-nothing, can solely transfer the entirety of allowable credit.
- If the modified AGI of the buyer exceeds limits, the buyer must repay the credit via recapture on an individual tax return in the calendar year in which credit was transferred.
- The IRS will issue advance payments via direct deposit (ACH) within 48 to 72 hours.
- Dealers are not required to verify a purchaser’s income for a credit transfer; liability falls on the buyer via certification of disclosure under perjury.
- Transferred tax credits are not taxable to dealers, they are merely repayment of an A/R from the IRS at the time of sale, so they are not subject to other credit caps, and no disclosure is required on tax returns for dealers.
Investing & Innovating in Mobility
In order to grow, automotive groups must invest outside of dealership retail by exploring corporate venture capital firms (CVCs) to build an effective investment team. Such CVCs invest in technologies that act as industry disruptors, which are critical to the evolution of dealerships.
While there are many venture capital firms investing in new technologies, CVCs are in a unique position to invest capital in startup companies that may revolutionize the automotive sector.
These processes require people who are passionate about innovation and hundreds of conversations to screen startups that will ultimately earn an investment from a dealership. Potential investments typically follow a path of initial screening, due diligence, idea sharing, presentation to an investment committee, legal review, and close and/or fund.
Through all of this, dealerships must consider the timing of their investment in a CVC, the team, and the potential ROI.
F&I Compliance and Proactive Planning Ideas
Many issues can affect finance and insurance compliance for dealerships. Among the top concerns are credit application fraud, identity theft, and potentially deceptive practices.
Strategies to prevent credit application fraud include:
- Signed, source credit application (handwritten, CRM, online)
- Signed, submitted credit application (RouteOne, Dealertrack, CUDL)
As for identity theft, potential threats have become more sophisticated over time. Dealerships must watch for stolen identities and synthetic ID theft, and ensure they adhere to both the Red Flags Rule and the Safeguards Rule.
The Red Flags Rule is enforced by the Federal Trade Commission (FTC) and requires automobile dealers to develop and implement a written identity theft prevention program designed to identify, detect, and respond to warning signs (or “red flags”) that indicate that a customer or potential customer could be using stolen information to obtain an indirect or direct loan or lease at their dealership.
Dealerships may encounter address discrepancy, Social Security number discrepancy, victim statements, and freezes. Each red flag requires different remediations.
Fortunately, dealerships can implement several program components to administer compliance, including a written Identity Theft Prevention Program (ITPP), employee training, financial transaction monitoring, red flag clearing documentation, annual program reviews, and vetting potential red flags. Dealerships can also engage software companies such as RouteOne, Dealertrack, and 700Credit to vet transactions.
Dealerships must also take into account the latest FTC rules in relation to potentially deceptive acts when it comes to sales. Primary areas of compliance for dealers within the FTC rules include:
- No misrepresentations
- Offering price, total payment, and add-ons optional
- No extraneous add-ons
- Get consumers’ consent
Future of the Auto Industry from a Financing Perspective
The auto industry experienced significant change in 2023 – most notably with ongoing strikes and economic ebbs and flows. This year ushers in a new period of increased interest rates.
Dealerships must weather this by paying attention to cash flow, good reporting, and precise record-keeping. It is also important to focus on liquidity, especially with the changing used car market and fluctuating values.
Profitability will be determined by looking at all service lines within a dealership. Diligence will also be crucial when evaluating and entering acquisitions (and to avoid overpaying).
Driving Success in Auto Retail: A Conversation with Industry Leaders
Daryl Kenningham, CEO of Group 1, and Alan Haig, President of Haig Partners, discussed how Group 1 is driving their organization forward in auto retail. Group 1 currently has 205 dealership locations in the U.S. and U.K., grossing approximately $16 billion in annual revenue.
The two touched on the future of auto retail, dealership acquisition strategies, technological innovations, and talent acquisition and retention within Group 1.
The Future of Auto Retail
In an acquisition-heavy market that continues to see consolidation, Kenningham noted that the winners in the business are those that will be able to drive scale in their business model and those that can anticipate and react to the ever-changing landscape. The auto retail consumer confidence is high; however, the industry is still undersupplied overall. Continued discipline in supply could help dealerships maintain healthier margins (that wouldn’t return to pre-COVID levels).
Dealership Acquisition Strategies
Kenningham describes Group 1’s acquisition strategy as obtaining larger stores with a bigger footprint and a larger impact, preferably in clusters; however, they still like standalone stores if they make sense. Their focus is on larger stores due to scalability, which will be a benefit as new cars gross starts to come down. A huge component to their acquisition strategy is integrating all stores on day one. Further, Group 1’s national contracts, lower back-office costs due to their consolidated operating model, and productivity increases add value to each acquisition.
Technological Innovations
Kenningham cautions to use technology where it doesn’t affect the customer experience; however, it can be used heavily to reduce cost, e.g., automated invoice processing. National branding across franchises may call for different technologies and capabilities compared to standalone entities.
Talent Acquisition & Retention
Technician shortages continue to be an issue (with the pandemic exacerbating an increase in labor rates). Positive experiences with technicians account for a huge portion of continued customer satisfaction and business loyalty. Kenningham further estimates that each empty stall costs a dealership approximately $17,000 in gross profit per month. When compared against the wage increases needed to retain skilled technicians, the benefit certainly outweighs the cost.
Attracting and retaining talent at Group 1 consists of a competitive pay structure, opportunities and paths to leadership roles, and plenty of ways to grow inside the company.
In conclusion, driving success in auto retail comes down to innovation, investing in customers, and driving scale in the business to overcome increasing costs.
Key Trends in the Electrification of the Auto Industry
As the electrification of the auto industry continues to grow, watch for the following focal points and projections.
Current Market
With advancements in battery technology, increased charging infrastructure, and declining costs, global sales of EVs are projected to rise significantly. Many countries have also pledged to ban the sale of internal combustion engine vehicles in the coming years, further driving the switch to electric. Currently, China dominates the global market share at 56% of all EV unit sales. The U.S. is second with 11%, while no other country makes up more than 5%. Most major manufacturers plan to be at least 50% EV by 2030 with Mercedes, Jaguar, and Volvo committing to 100% EV by 2030.
For these reasons, major automakers are investing heavily in EV development and are expected to introduce a wide range of new electric models.
However, there are headwinds to adoption of EVs. Cost parity, consumer adoption, and charging networks all prove to be challenges in the industry.
As EV adoption increases, the need for a robust charging infrastructure becomes crucial. Governments, utility companies, and private entities are investing in the global expansion of charging networks. Fast-charging technologies and improvements in charging speeds will also lead to an enhanced user experience.
In addition to charging infrastructure, battery technology is a key driver in EV adoption. Expect further advancements in battery chemistry, energy density, and charging capabilities. Solid-state batteries, which offer higher energy density and faster charging, could become commercially viable, revolutionizing the industry. However, the UAW strikes will have significant cost impact to the Big Three companies leading the way.
We are also seeing an increase in ownership costs with an average of increased insurance premiums, depreciation, financing interest and fees/taxes with BEV over traditional ICE ownership.
Credits administration poses another curveball to dealerships – dealers must consider how they will manage the increased administration of EV tax credits that came with the Inflation Reduction Act (IRA). Dealers can anticipate their customers asking questions about which EV models qualify, how they can benefit and claim government tax incentives, etc.
Overall, the electrification of the auto industry will continue to accelerate beyond 2023, driven by technology advancements, government regulations, and increasing consumer demand for sustainable transportation solutions.
Dealerships Buy/Sell Update
The 2023 buy/sell market had earnings down 23% in the first half of 2023, but transaction volume is up 26% during the same time period. In addition, the dealership industry experienced a significant uptick in larger transactions, with 69% of total transactions involving multidealership groups, which paved the way for record transaction volume.
As we start 2024, new vehicle gross profit is expected to trend down, but remain well above pre-COVID levels due to lower days’ supply of inventory at most franchises. Despite earnings being down in the first half of 2023, net profits were still double pre-COVID averages and are expected to gradually rise over time.
This strong outlook, coupled with favorable returns on equity for dealerships versus alternative investments, will act as a catalyst for both private and publicly held groups to remain acquisitive over the next several years.
On the sell-side, many dealers are uneasy about factory relationships, most notably facility demands for electric vehicle product offerings and OEMs hinting at being more involved in consumer relationships with direct sales to customers. Furthermore, the trend of rapid consolidation within the industry has made it more challenging for smaller dealers to compete with larger groups due to scale. These headwinds for dealers will provide a healthy supply of sellers, which should fuel the buy/sell environment with strong buyer demand.
Moreover, dealerships should keep valuation trends within the buy/sell market in mind. Dealership valuations are still being driven by future profitability, with most buyers using a 4–5% net-to-sales ratio as a predicting benchmark. Luxury franchises have been viewed as attractive acquisition targets the past few years, given their customer base tends to be somewhat insulated to uncertainties in the economy and financial markets.
In contrast, domestic franchises continue to see hindrances given recent union strikes and likely impacts to production costs, which will drive prices higher and put pressure on consumer brand loyalty. Only time, economic stability, consumer habits, and dealership preparations will tell where the buy/sell market leads.
Conclusion
In conclusion, the dealerships industry is complex and there are multiple areas within the industry that can directly or indirectly influence your financials. Our team has over 160 experienced professionals dedicated to Dealerships, with a strong history of understanding how current events could affect a dealership. To learn more about any of the topics discussed at the AICPA conference and what your dealership may want to consider, please reach out to a Forvis Mazars professional.