Every dealer has a preference on what type of capital they use to purchase inventory. Each dealer has the choice to use either the cash they have on hand, to use auto floor plans, or use the loans they’ve secured from banks and other financial institutions. Each form of capital comes with its own risks and rewards. However, dealers that primarily use cash could be missing out on some of the benefits an auto floor plan can provide.
The Cash Conundrum
Let’s say someone asks a dealer to invest $10,000, and also makes the personal guarantee that the money invested today will be worth $50 less the second the money is deposited. Of course, a discerning dealer would think twice about making that investment. However, what some dealers don’t realize is taking that deal is exactly what happens when they pay cash for their inventory.
From the beginning of the inventory / retail stocking process, dealers are utilizing capital. At auction, the reason a dealer will win a bid is simply because they were willing to pay more than anyone else. This is of course, a calculated risk. Often, the dealer’s sale of their auction purchase will result in a profit. However, there is always the possibility that the purchased car won’t sell.
Any car purchased will eventually depreciate in value. The longer a car sits on a lot, the more that car will depreciate. Purchasing a vehicle with cash means that the money initially spent on the car will also depreciate, and the vehicle will eventually be valued at less than the dealer’s initial investment. In addition, purchasing inventory with cash will limit a dealer’s options to keep their money working for the business.
If a car sits on a dealer’s lot beyond 60 days, the dealer will likely be pretty motivated to sell that particular vehicle. However, at this point, the dealer’s cash is now tied up in the vehicle. Purchasing another vehicle isn’t a possibility. In addition, the dealer isn’t likely to earn back their initial investment if they try to re-sell the vehicle at auction. When the dealer first won the unit at auction, they were already willing to pay more than anyone else.
The time the vehicle spent on the lot didn’t increase the vehicle’s value either, so the dealer is already facing a loss. It also doesn’t help that the dealer doesn’t have time to wait for a buyer. In order to purchase another car that is a better position to sell, a dealer needs cash and they needed it yesterday.
But doesn’t the same thing happen when using auto floor plans?
Technically, that same vehicle will still depreciate whether or not a dealer uses cash or a floor plan. However, when a dealer uses a floor plan they have more options available than if they paid cash. With a floor plan, a dealer can pay a small amount of the car off at a time, they can extend a vehicle, or they can buy down their depreciation over a period of time. With a floor plan, a dealer has extra capital on hand to ensure their ability to purchase more inventory.
At NextGear Capital we recommend a dealer’s budget for stocking inventory to be a 70/30 mix of their floor plan and cash, respectively. Using a floor plan to stock inventory ensures a dealer can buy enough vehicles to meet the needs of their market, and the cash on hand ensures a dealer can pay for their expenses.
Buying inventory with cash can limit the actions a dealer can take to help their dealership profit and succeed. However, auto floor plans give a dealership the capital and flexibility needed to purchase the desired inventory for their market.