Cash In Deal Policy in Today’s Wholesale Climate
I just got off the telephone with a dealer who was complaining he hadn’t been able to buy a single unit at the auction today. He claimed every car he wanted went for over $3500 and, with a cash in deal policy of $2500, average reconditioning expenses of just about $700 and average customer down of just under $800, he just couldn’t make $3500 cost vehicles fit his business model. Although the numbers may have been a little different in each case, he is certainly not the first dealer I have had that discussion with.
July’s Manheim Used Vehicle Value Index was 125.9, which represented a 5.9% increase from its year-ago level. In January, 2009, the index stood at 101.7, just a little higher than the benchmark value of 100 created when the index started in January of 2005. It has steadily risen over the last 2 ½ years, reaching a record high of 127.8 in May of this year. What that basically means is that a car that sold for $4000 in January of 2009 would cost $5000 today. This 24% increase over the last two and a half years has proven costly, and sometimes even deadly, to dealers engaged in dealer controlled financing.
Let’s take a look at what Cash In Deal is.
Every time a dealership finances a vehicle, a certain amount of the money the dealership has invested in that vehicle is not recovered even after the customer’s down payment. This amount is the Cash In Deal or, as it is often abbreviated, CID. It is the original cost of a vehicle plus all expenses minus the total cash down and the net trade allowance. In order to ensure the dealership properly manages the cash it has available and make certain the dealership maintains proper capitalization, the dealer must establish a dollar amount of the maximum Cash In Deal allowed, which then also establishes down payment requirements and inventory replacement cost. The Cash In Deal policy is designed to control the utilization of cash on a per vehicle basis.
Your Business Model Determines Your Inventory
• Amount of $ you want to risk every month / # of units you project selling = Your Average Cash In Deal (CID)
• Average Cash In Deal + Average Down Payment you expect to collect from customers = Average Total Inventory Cost you must maintain
• Average Inventory Cost – Anticipated Reconditioning Expenses = Price of Inventory you should be buying
• Let’s say you have a pool of $480,000 to loan
• $480,000 / 12 months = $40,000 per month
• $40,000 / 20 sales per month = $2000 per sale CID
• $2000 CID + $700 Avg. Down Payment = $2700 Inventory Cost
• $2700 Inventory Cost - $500 Avg. Recon = $2200 Avg. Purchase Price
A $1,000 increase in Cash In Deal in your business model may require as much as an additional $250-300K in capital in just one year for a small dealer.
Given the dramatic increases in wholesale vehicle costs over the past 2 ½ years, dealer controlled financing dealers have faced two choices:
Increase their cash in deal policy. For established dealers with a sufficient number of accounts to generate the necessary increased funds through incoming car payments have faced less of a struggle but their cash flow has still been affected dramatically with more of the available capital tied up in inventory. Smaller dealers who choose this option have generally needed to find additional sources of capital through private investors, loans, floor planning of inventory or selling accounts. None of these options are particularly desirable but they have become a business necessity for many.
Maintain their current cash in deal policy which results in offering their customer older vehicles with higher mileages. In a Manheim study, vehicles purchased in a 6 week period from April 1 to May 15 of 2009 for $4000 - $5000 averaged 85,272 miles. Vehicles purchased in the same price range during the same period in 2011 averaged 111,896 miles; a 31% increase. This alternative is no more desirable than the first but is the reality for most dealers with no ready source of the available capital needed for option 1.
Increased cash in deal means a higher selling price and, since the average down payment collected from customers had remained fairly steady for a number of years, the only two ways available to adjust retail installment contract terms to account for the higher selling price is through either higher payments or longer terms. Since the average personal incomes have also not risen in a number of years, and in some cases have decreased, higher payments are a road that must be travelled carefully. It makes the verification process in underwriting I discussed last month even more critical. And the fear with extending the length of contracts is that longer terms can produce two different problems that can have detrimental effects on a dealership:
The typical dealer controlled financing customer changes jobs and residences more frequently than does the general populace. A longer term increases the risk that your customer may experience a change or an event in their life that will negatively affect their ability to pay.
Longer terms also increase the risk that the vehicle itself will have mechanical issues beyond the customer’s ability to repair. Terms that run longer than the expected life of the vehicle can have a devastating effect on collections and charge-offs.
New cars sales, the engine that drives wholesale used car values, have averaged about 11.7 million vehicles over the past 3 years. According to JD Powers, that level is expected to rise to 12.6 million vehicles in 2011 and 14.1 million in 2012 but Edmunds.com predicts new car sales will not return to the pre-recession levels of the 16.1 million vehicles sold in 2007 before 2016. That means that, while we may see some easing of used car wholesale prices over the next few years, this era of high used car prices is liable to be with us for several more years.
Waiting for used car wholesale prices to go down will not make this issue go away. Whichever method you choose to use – raising your CID policy or keeping your policy as it is and offering older, higher mileage vehicles than you previously did – you must make the necessary adjustments to survive the new reality of higher wholesale prices.
One method many dealers have used to try to cushion the blow of high wholesale used car prices is to change the ways they acquire inventory. Next month we will take a look at some strategies to find inventory that may be less expensive than your current method.
As published in Auto Dealer Monthly magazine
by Al Mosher
Al Mosher is the General Manager for Constellation Automotive Solutions. Al has almost 30 years experience in the auto industry; having served in both sales and finance management at new vehicle stores before spending the last 13 years as a Manager, General Manager and consultant in the Buy Here – Pay Here industry.
Al worked as a consultant for CarBiz USA beginning in 2000 and joined Constellation’s DCF Consulting Group in 2008. He added the role of GM in January 2012. He has written numerous training manuals and conducted seminars for dealers in the Buy Here – Pay Here business. Al has also been featured as a speaker by the NIADA and his articles regularly appear in industry publications.