Why Dealer Principals and Controllers Need to Understand Parts Dept.
Many car dealers know how many sales went unclosed on the showroom floor from the previous weekend, but have no idea how many lost sales have happened over the past six months in the parts department.
September 8, 2016
When customers bring their cars in for service, they want it repaired as quickly as possible.
For this reason, the dealership parts department within a dealership requires timely access to inventory, generally without question. Parts is one of the only profit centers within a dealership that has unlimited access to funds and, due to the time-sensitive requirements of their customers, is at liberty to make purchases that do not require pre-authorization.
What Does This Mean?
As the parts department is viewed as a necessary component of fixed operations, and typically employs a formulaic profit margin, dealers and controllers focus more on vehicle sales and variable operations and do not question the details of fixed operations, especially the parts department.
Many do not have a significant understanding of the parts department, how the inventory and billing systems are set up and managed or how it really works, so questioning on the process is unlikely.
Dealers are more likely to know the age of the used cars on the lot, but not the obsolescence of the parts carried in inventory. Many know how many deals went unclosed on the sales floor from the past weekend, but have no idea how many sales have been lost over the past six months in the parts department.
Why Is This Significant?
While we trust our parts departments to properly manage their areas of responsibility and serve the best interests of the dealership, there may be instances of mismanagement or unforeseen circumstances that affect overall sales and missed opportunities to cut costs or better manage inventory.
As a best practice, there always should be internal controls in place to review and understand cost areas such as parts and as a way to identify problems before they cut into profits.
What Should Controller, Dealer Principal Review?
Start reviewing the inventory turns in the parts department. Some dealer-management systems may be able to put key indicators on your “dashboard” that pertain to the parts department for daily review alongside new- and used-vehicle sales.
If that information is not available, take a look at the monthly analysis on a regular basis. At a minimum, controllers and dealers should be aware of several key performance indicators with regards to inventory turns.
Gross Inventory Turnover
Gross turnover is represented by the ratio of the cost of goods sold to the average inventory value over a certain period of time. The formula for calculating gross turnover is as follows:
Cost of goods sold (COGS)/Average inventory value = Gross turnover
For example, if the COGS is $750,000 and the average inventory value over 12 months is $125,000, the gross turnover ratio would be 6.0, or six times per year.
Using this gross turns method represents all parts inventory, including special orders and emergency purchases, so it doesn’t give a true picture of the parts departments’ efficiency – the return on the investment of the parts department isn’t truly calculated using this method. We suggest using another measurement, True Turns, as well.
True Turnover
True turnover represents a clearer picture of the return on investment of the parts inventory. It is the best indicator of how the managed inventory is meeting the needs of the customers, whether counter retail, wholesale or service customers, since it uses only parts sold from stock to calculate the true turn of the inventory.
Gross turns include emergency purchases, which may fill an immediate need but in the long run increase the acquisition costs of parts and reduce your earned discount amount. Gross turns do not add to the return reserve you earn from the manufacturer.
Therefore, parts sold from stock generate higher gross profit margins, which translate to higher net profits. Consequently, true inventory turns are a good measure of how profitable the dealership's inventory investment really is.
The preferred formula for calculating the true turn:
Stock order performance (%) X gross turnover = true turnover
Stock order performance = stock order purchases/total purchases
So a parts department that has stock order purchases of $400,000 out of a total inventory of $500,000 is said to have a stock order performance of 80%.
Hence, you could calculate true turns by either:
$400,000 (stock orders/125,000 (average inventory) = 3.2 true turns
Or by:
0.80 (stock order performance) X 4.0 (gross turns) = 3.2 true turns
Although you do not have to calculate this ratio yourself, as your DMS should be able to, it is a good idea to understand where the numbers come from and what they mean.
Aim for a stock order performance of 75%-85% for weekly stock order deliveries and 85%-95% for daily stock order deliveries.
A good ratio to have as your true turn is six or more with a daily stock order and four to five with a weekly stock order.
Fill Rate
Fill rate is an important metric because it tells you the sales that come from your inventory vs. all the requested parts. The fill rate is:
COGS (-) emergency purchases (-) special orders)/COGS + lost sales
For example, if you had a demand for a part 100 times and you can go to the bin and pull that part without having to order 80 times, you have a fill rate of 80%. It is recommended you have a fill rate of at least 90% in your parts department.
What Can Controller, Dealer Do?
To begin, make sure the parts manager has policies and procedures in place that ensure the on-hand counts recorded in your DMS are correct. They should be spot-checking bins on a regular basis to keep an accurate and perpetual inventory year round, instead of just annually.
Ask your parts manager if lost sales are being recorded properly and review together what is a lost sale so there is no doubt.
Review the monthly analysis with the parts manager and address any areas that need to be improved. Are the true turns within an acceptable guideline? What is the fill rate? Review stocking levels and phase-in and phase-put criteria that is set up in the DMS. Do these need to be tweaked?
It also is recommended that the controller review the parts-inventory investment amount (the parts pad amount) to the general ledger on a monthly basis, noting any variances that occur from work in progress, unposted transactions such as invoices, appreciation/depreciation and in-transit parts. If a significant variance still exists, it should be investigated and a physical inventory should be conducted by an outside vendor.
Jill Pastore is currently a senior accountant at Citrin Cooperman & Co. She has over 20 years of dealership experience as a dealership controller and business consultant at Reynolds and Reynolds.
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