“Determining the number of times that inventory is sold during the year provides some measure of its liquidity and the ability of the company to convert inventories to cash quickly if that were to become necessary.
“When turnover is slow, it may indicate that inventories are not a liquid asset and suggest they should be excluded from that category for analytical purposes.
“On the other hand, when turnover is quite rapid, that is when inventory is sold several times each year, the liquid character of inventory can provide funds if needed in the short term and may protect the firm against inventory obsolescence.”
That's from Harvard College of Business, and it certainly applies to dealerships' used-car operations.
Question: With regard to assets, where is a dealership most vulnerable?
Answer: Used vehicles.
New vehicles are “protected” by an invoice. Parts have a published value. But used vehicles are depreciating assets. They represent a great deal of our cash. So what can we do to protect ourselves? We can proactively manage this asset from a financial standpoint.
One of the most important measurements of used-vehicle inventory management is turnover, or turn. Turn is a financial term as opposed to aging, which is a reflection of time between acquisition and disposal of inventory.
We often hear managers say their dealerships have a 60-day turn policy when, in fact, they have a 60-day aging policy. Unfortunately, with few exceptions, when asked the dealership's dollar inventory turn policy, many managers don't know.
From a financial management perspective, I, as a dealer, only want to know the number of times my dollars are turned monthly and without looking at any other information, I have a good idea of how well managed the department is. It's important to educate our managers on the importance of frequent turns and work with them to accomplish our goal.
First, let me provide the formula for calculating turn: 1) $ cost of sales (most recent month) divided by $ used-vehicle inventory (month end) equals number dollar turns for period, 2) Number dollar turns for period multiplied by 12 months equals annual dollar turns, 3) 365 days divided by annual dollar turns equals number of days required to turn inventory.
Our turn goal for used vehicles is 30 days. Each 30-day period, we want to turn our dollars 100%. I recommend you track used cars and used trucks separately.
Is a 30-day turn realistic in today's business environment? Yes. Several clients average turning their total car and truck inventory within 30 days and, in some cases, less.
During July 2004, our benchmark client turn results were as follows:
For your information, .6 turns equates to 51 days and .5 equates to 61 days to turn your dollars.
If our goal is one turn each 30-day period, then possibly we're carrying too much used-vehicle inventory.
We know from multiple studies that dealers with the highest turn traditionally have the highest gross profit and least wholesale loss. If we have this same used- vehicle dollar inventory in September, when both the new- and used-vehicle business traditionally slows from the July-August period, what are we setting ourselves up for in the event we need to convert some inventory to cash?
I know several dealers who set their dollar inventory level based on turn. For example, if I have $1 million in used-truck inventory and my turn has been averaging .5, I would lower my inventory to $500,000.
When I prove the ability to turn this inventory monthly, I can then increase my inventory dollars. Yes, this can be accomplished without sacrificing volume. If I'm only turning the dollar inventory .5 times per month, chances are my volume is lacking anyway.
A few ways to facilitate an increased turn include maintaining, at most, a 45-day supply of cars and trucks, stocking only vehicles that meet your sales profile/history and following a disciplined aging policy.
Once you adopt the disciplines, then the benefits and rewards will more than outweigh the effort associated with always trying to play catch up.
Tony Noland is the president and CEO of NCM Associates, Inc. He's at [email protected]