Posted on Apr 3, 2018

In the life cycle of any auto dealership, there will be times when cash flow is tight. Buy here pay here dealers in particular face complexity to ensure enough inventory is on hand to attract buyers — and offset that investment with a healthy flow through collections and debt management. This balance is never perfect. Dealers need strong banking and/or equity relationships that will extend credit to fill in the cash flow gaps.

Debt Management is Proactive

Even if their balance sheet is healthy, dealers on the shy side of $1 million in receivables will likely get a less favorable interest rate on credit than more established or larger dealers. This does not mean that smaller dealers should accept rates of 10 to 15 percent. It pays to shop around and to understand how the bank or private equity firm will consider the characteristics explained above to justify their terms.

By working with your CPA, you can provide the lender with financial statements and accounting that aligns with their expectations. As part of the terms of the loan, dealers may be required to provide reviewed or audited financial statements. Because of this additional expense and also to get more favorable terms, it’s important for dealers to actively seek lower interest rates. It is perfectly acceptable to shop around. Contact competing banks as well as your existing lender and ask about new credit options. Talk to colleagues about the banks they are using. Request multiple offers.

Strong accounting, tax and compliance practices help with this process. On the accounting side, owners need regular financial statement preparation to view trends and forecast cash flow — helping them prepare for lending conversations and extensions of credit at the right time each year. On the tax side, the number one tax planning technique for buy here pay here dealers is the discount (or loss) on the sale of notes from the dealership to the RFC, which requires cash. Dealers may also qualify for opportunities such as bonus depreciation and deductions with regard to employee perks and compensation.

Management may also consider a review of operational efficiencies or gaps in controls that can affect cash flow. Keep in mind that every dealership is different when it comes to managing cash flow, so best practices must occur within your own dealership.

As buy here pay here dealerships grow to portfolios of $4 million and above, more favorable financing opens up. But it’s not a guaranteed scenario. Dealers should weigh the benefits of obtaining more financing against the extra administrative costs of public accounting services.

Once you have the credit you need, there are various ways to reinvest in your business. Some dealers may decide to purchase their location — adding real estate holdings that support the extension of credit in the future. If the dealership also has a service department, cash flow can be set aside to cover repairs and maintenance on recently sold cars. Some dealers choose to cover repairs on cars shortly after purchase in order to support the customer’s ability and willingness to keep making monthly payments. For example, a repair may cost $800, but it leads to another six to 12 months of customer payments.

Compensation is another area that cash flow can support. Attracting and keeping good back office personnel supports collections, which in turn supports the business. Dealers may also consider additional compensation for good salespeople.

Let’s say you’ve done as much proactive management that you can. At certain points in the life of a dealership, you will still experience challenges. Some of these challenges can’t be handled alone. Whether you’re with a big bank and have secured a favorable interest rate or your dealership is still considered high risk for lenders, don’t ignore cash flow problems. Your CPA can help you formulate a plan to show numbers and communicate effectively with lenders in a way that is focused on solutions rather than the immediate problem. Lenders don’t like to call a loan for a short-term issue, and there is usually room for negotiation on loan modifications that will support cash flow as well as repayment.

However, year-over-year problems make lenders less willing to keep taking a risk on default. As soon as an issue comes to light, prepare your strategy to keep a strong lender relationship. Work through it like you and your lender are on the same side.  It’s in the best interests of you and the lender to find a solution.

Debt Management Supports Valuation

It is also in the best interests of the dealership long-term to show a consistent history of loan financing, healthy cash flow and debt management. Owners want to show a return on investment and consistent profitability, tied to valuation of the business.

There are different approaches to valuation. A key component, however, is determining equity value, which is the market value of the dealership assets minus the market value of its liabilities.

Assets include such things as the dealership’s auto inventory and fixed assets including real estate. They can include intangible assets such as the goodwill value of the dealership’s name and location, sales and service agreements, and also synergies such as multiple locations and strong management.

Liabilities will include debt, any excess compensation, tax and rent issues, inventories and contingent liabilities such as environmental issues related to the storage and disposal of fuel, oil or batteries.

The bottom line is that a well-performing portfolio, a good location and healthy foot traffic — combined with properly managed debt — will be attractive to a potential buyer. A dealership that is attractive to lenders is also attractive to buyers or outside investors, even with debt factored in.

If your dealership struggles with debt management or cash flow either intermittently or throughout the year, don’t let it hinder opportunities to grow. Talk to the team in Cornwell Jackson’s auto dealership practice group. They will help you understand the proper structure of financial statements to support proactive lender conversations.

Download the Whitepaper: Use Debt to Increase Cash Flow

Scott Bates is an assurance and business services partner for Cornwell Jackson and supports the firms auto dealership practice. His clients include small business owners for whom he directs a team that provides outsourced accounting solutions, assurance, tax compliance services, and strategic advice. If you would like to learn more about how this topic might affect your business, please email or call Scott Bates.

Originally published on February 29, 2016. Updated on April 3, 2018. 

Posted on Mar 6, 2018

Related finance companies have been around for a long time…and so have the IRS guidelines for valid RFCs that auto dealerships must follow for tax compliance.

Like third-party lenders, RFCs can offer to acquire receivables at a 25-40 percent, up-front discount of fair market value (FMV). Problems arise, however, when the discount is not based on FMV or when the dealer cannot prove an actual benefit from the transaction of either improving cash flow or shifting risk.

After the transaction, if the dealer is still directly responsible for the asset in terms of collecting payments, owning title, or collecting any insurance proceeds, for example, the IRS will question whether a sale of property actually occurred.

Discounts on Fair Market Value

A discount is typically acceptable in nearly all transfers of receivables. The level of discount is influenced by credit history, past payment history, time on the note and age of the vehicle. Related Finance Companies can offer to buy notes at a discount regardless of whether they buy in bulk or choose transactions selectively.

The IRS can consider the following in determining whether a dealer sold receivables to an RFC at fair market value:

  • Car jackets for loans that were sold to the RFC compared to loans that were sold to third parties
    • Could the debtor have obtained financing from third parties or was it unlikely? The car jacket usually includes a credit report on the borrower. If the discount rate is large, the customer will have a poor credit history.
    • If these loans were sold to the RFC at FMV, then similar loans sold to third parties will have a similar discount rate.
  • Frequency of payments on the loan required: weekly, biweekly, or monthly?
    • Required weekly payments generally indicate higher credit risk.
  • The dealer’s collection history on the loans prior to the discount date
    • Poor customer collections decrease the value of the note receivables.
    • Average dealer markup on dealer-financed sales compared to the average dealer markup on third-party financed and cash sales
  • If the markup is the same, then the face amount of the note should be the FMV of the note on the loan date. To the extent the markup is higher on dealer-financed sales, the FMV of the loans are less than their face value on the loan date.

In addition to these considerations of FMV, the IRS will look at the date of the discount relative to the date of the loan transaction. The closer the discount date is to the loan date, the less likely that factors such as a change in interest rates could impact the FMV calculation.

Related Finance Companies: Cash and Risk Benefits

The IRS may also determine that the transfer of dealer notes to the RFC was not a true sale of property based upon the following factors:

  • Upon the transfer of the notes, the dealer still had burdens of ownership:
    • Dealer’s employees collected the payments and performed repossessions
    • Dealer bared the risks of the credit-worthiness of the notes
    • Dealer’s financial position did not change when the notes were transferred to the RFC
  • RFC was thinly capitalized
  • Dealer, not the RFC, was responsible for repossessions
  • Title was not transferred to the RFC and RFC could not have sold the notes
  • Borrowers were not notified that the loan was reassigned to the RFC
  • If a vehicle was damaged in an accident, the dealer (not the RFC) had the right to any insurance proceeds
  • No written sales contracts were drawn up between the dealer and the RFC

If the IRS determines that no actual sales transaction took place with an entity separate from the dealership, auditors may perform a tax adjustment calculation.

This calculation equals the dealer’s increase in taxable income, which can be substantial depending on the number of transactions in a given tax year or years. All other unrelated income or expenses of the RFC will also remain on the RFC return.

Again, it can be very complex and time-consuming to regularly review the multiple areas of your entity forms, operations, transactions and tax reporting to ensure full compliance with the IRS on related finance company operations. This is why many dealerships fall short in the event of an IRS query.

To help you determine if it’s the right time to review financial management of your auto dealership or RFC operations, the IRS provides a helpful checklist of common questions to consider.

Download Cornwell Jackson’s whitepaper and checklist on RFC risk management.

Scott Bates is an assurance and business services partner for Cornwell Jackson and supports the firms auto dealership practice. His clients include small business owners for whom he directs a team that provides outsourced accounting solutions, assurance, tax compliance services, and strategic advice. If you would like to learn more about how this topic might affect your business, please email or call Scott Bates.

 

Blog originally published Dec. 4, 2015. Updated on March 6, 2018. 

Posted on Feb 20, 2018

The average used auto dealership operates differently today than it did prior to 2008. Although margins can be healthier for “buy here pay here” dealers than for market rate dealers, accounting for these dealerships is complex. And cash flow is a constant concern. Dealers must balance inventory investment with collections. Yet, receivables alone don’t support healthy cash flow.

Receivables Rarely Keep Lights On for Auto Dealerships

There are two common scenarios that lead to buy here pay here dealership cash flow problems. Some dealers focus too much on buying vehicles, tying up their cash in inventory and experiencing a lag between car sales and collections. For the dealerships that try to balance inventory investment with receivables, it is difficult to sustain cash flow due to the car financing default ratios. Until they reach a certain size, dealers don’t collect enough in receivables alone to support regular investment in inventory, coverage of overhead or anything else.

If the dealership has common ownership in a related finance company (RFC), then there is the additional burden of ensuring the RFC has enough cash on hand to pay the dealership for the vehicle at the time of each financing transaction. In a previous article, we explained that RFCs allow dealerships to work with consumers who have little, no or bad credit. The consumer is able to finance a car through the RFC, separating the dealership from direct payment collections and other potential liability. The dealership collects cash up front. The RFC earns the income as it is earned from the car buyer’s payments.

Whether dealers are focused on inventory, receivables or expanding their transactions through RFCs, they will typically experience gaps in steady cash flow without some type of debt or equity contribution. A secure supply of cash flow requires regular management and vigilance as well as education around how to develop a healthy banking relationship. But there are appropriate ways to use debt (credit) to support cash flow while maintaining a healthy balance sheet.

Healthy Dealers Get Credit and Increase Cash Flow

It stands to reason that dealerships with good access to credit are considered healthy among other lenders or equity groups. They tend to have several things in common:

  • Good location: Geography still matters in this industry, so lenders or investors will consider the physical location of a dealership, its longevity and the size of the city to support extension of credit.
  • Good traffic: Traffic counts around the dealership will support projections of customer walk-ins, brand visibility and expectations for sales volume.
  • Strong collections: The proof is in the numbers. Dealerships must show an emphasis on receivables directly as well as through an RFC. Unlike the IRS, however, lenders and investors will view the dealership and RFC as one entity when extending credit to one or the other.
  • Well-performing loan portfolio: Although the industry standard is that just 10 percent of notes will survive the entire term, dealers must show that the majority of the portfolio is performing. Of course, recent notes are considered healthier than notes extending into year three or four when customer defaults and refinancing tend to occur.
  • Healthy margins: Lenders and investors want to see a profit margin year over year in the dealership and the RFC.

If your dealership struggles with cash flow either intermittently or throughout the year, don’t let it hinder opportunities to grow. Talk to the team in Cornwell Jackson’s auto dealership practice group. They will help you understand the proper structure of financial statements to support proactive lender conversations.

Scott Bates is an assurance and business services partner for Cornwell Jackson and supports the firms auto dealership practice. His clients include small business owners for whom he directs a team that provides outsourced accounting solutions, assurance, tax compliance services, and strategic advice. If you would like to learn more about how this topic might affect your business, please email or call Scott Bates.

Originally published on February 7, 2016. Updated on February 20, 2018. 

Posted on Feb 20, 2018

Related finance companies (RFCs) were not designed to be a tax-planning vehicle to reduce or defer auto dealership income. If the IRS validity test discovers noncompliance that cannot be explained in the RFC’s or dealership’s documentation, additional taxes and penalties can be severe.

We find that many RFCs and dealers do not regularly review their operating agreements or operations to comply with validity factors for the RFC and its transactions. The process is understandably time consuming and complex. You can rest assured, however, that if the RFC receives an IRS query, then a dealership query often follows.

RFCs are usually set up as S Corporations. The RFC acts as the lender in the dealer’s financing of used vehicles. The notes are sold to the RFC at a discount due to the higher risk the RFC incurs in the transaction. The RFC accrues the income as it is earned from the car buyer’s weekly or bi-weekly payments.  The dealership collects cash up front, then books a current and deducted loss for the difference between the full contract and the discounted contract.

IRS Validity Test

According to the IRS, a valid RFC must have the following characteristics.

  • When the finance contract is sold to the RFC, title has been transferred to the RFC in accordance with title and lien holder laws
  • The discounting of the car dealer’s receivables are sold to the RFC at their fair market value
  • There is a written arms-length contract between the dealership and the RFC
  • The finance contracts are normally sold without recourse between the two related parties
  • The RFC is responsible for repossessions
  • The RFC is operated as a separate entity from the dealership and has the following characteristics:
    • Adequate capital to pay for the contracts
    • Meets all state and local licensing requirements
    • Maintains its own bank accounts
    • Has its own address and phone number and operates as a separate entity from the dealership
    • Maintains its own books
    • Has its own employees who are compensated directly by the RFC
    • Pays its own expenses
    • Customers make payments to the RFC, not to the dealership

The IRS Audit Technique Guide cites two common issues that put the validity of the RFC into question. Either the dealership and RFC do not treat and record the sale and financing properly or it is found that the RFC is operating like a shell company rather than a legitimate separate entity:

  • At the time of each transaction, the RFC must show actual cash reserves in its own bank accounts to pay the dealer; the dealer in turn must record receipt of payment for the note. Each entity must have separate journal entries for the transaction. If journal entries don’t match up, the IRS may disallow the transaction.
  • As for its validity as a separate entity, if the RFC doesn’t have a separate address and does not advertise itself as a separate company, it factors into the validity test. It must also be proven that the RFC is directly collecting payments and paying actual employees.

If the IRS does not view the RFC as a separate entity by these tests of validity, it will not allow the dealership to claim a deduction for losses on the sale of discounted vehicles to the RFC. It will defer to related party rules under IRS code 267 that do not allow loss deductions in transactions made between related persons. Without proper structuring as a separate operation, an RFC can become a liability.

The RFC may be completely valid, and the legal form can be proven, but dealers and managers must be confident in their ability to show proof and documentation in the event of an IRS query or audit. Sharing staff or running RFC bookkeeping and administration through the dealership to save now can prove costly in taxes and penalties later on. The IRS may determine that the RFC is not a valid separate entity. This finding, in effect, invalidates the cash method of accounting for the sale of notes to the RFC.

Interested in more details about RFCs and auto dealership accounting? Download our whitepaper on RFCs.

Continue Reading: Fair Market Value Test Can Render RFCs Invalid

Scott Bates is an assurance and business services partner for Cornwell Jackson and supports the firms auto dealership practice. His clients include small business owners for whom he directs a team that provides outsourced accounting solutions, assurance, tax compliance services, and strategic advice. If you would like to learn more about how this topic might affect your business, please email or call Scott Bates.

Blog originally published Dec. 3, 2015. Updated on February 20, 2018. 

Posted on Feb 6, 2018

A related finance company can provide a useful service to the public when operated to help auto dealerships sell cars to people who need an alternative financing method. This does not mean that every dealer should operate an RFC. Rather than a benefit to the dealer, it can actually be a financial drain due to unnecessary overhead costs. In addition, the Internal Revenue Service has imposed increased scrutiny on RFCs over the last few years to crack down on potential noncompliance issues.

Pros of Creating an RFC

There are pros and cons to RFC creation and operation. Let’s look at the pros first. These entities allow dealerships to work with consumers who have little, no or bad credit. The consumer is able to finance a car through the RFC, separating the dealership from direct payment collections and insulating it from possible bad publicity if the loans default. Because interest rates charged in a “buy here, pay here” car purchase are substantially higher than with traditional loans, an RFC must maintain a larger level of cash reserves. The RFC keeps the default financial risk separate from the dealership.

History shows that when an RFC is involved in collection of auto loan payments, customers are less likely to default than when making payments directly to the dealer. In addition, RFC discount rates may be lower than what a dealer would obtain from third party lenders — resulting in a better profit per transaction.

Another benefit, depending on the licensing and regulatory requirements of the state, is the ability for the dealer to isolate liability for violation of licensing or capital requirements for finance companies. Such violations, if they occurred in the operation of the RFC, wouldn’t affect normal operation of the dealership.

The downside of using a Related Finance Company

In fact, RFCs work very well for dealerships that have approximately $1 million or more in receivables. This is the breakeven point if you look closely at the numbers of any given transaction compared to a straight retail sale as well as the overall net benefit on any income tax deferrals. Even at $1 million, however, dealers and managers need to consider very seriously if the additional overhead costs and administration of an RFC result in an overall financial benefit.  

An RFC is, after all, a separate entity and must be operated as such to meet IRS guidelines. This includes many fixed operating costs along with the costs of employing separate staff and ideally maintaining a separate location. Dealers need to factor in the time and money spent on creating the entity and then operating it. You must compare that ongoing expense to the potential savings based on your receivables.

As receivables grow past $1 million, an RFC starts to make more sense. Well-managed RFCs can offer discount rates much lower than rates offered by a third-party lender. Dealers can also rely on RFC experience to be more selective when extending credit, improving the quality of transactions. Proper management is the key, including the burden of ongoing diligence to satisfy IRS requirements. The trouble starts when the structure and operation of the RFC fails to pass the IRS validity test as an entity that is truly separate from the dealership.

Interested in more details about RFCs and auto dealership accounting? Download our whitepaper.

Continue Reading: Does Your RFC Pass the IRS Validity Test?  

Scott Bates is an assurance and business services partner for Cornwell Jackson and supports the firms auto dealership practice. His clients include small business owners for whom he directs a team that provides outsourced accounting solutions, assurance, tax compliance services, and strategic advice. If you would like to learn more about how this topic might affect your business, please email or call Scott Bates.

Blog originally published Dec. 2, 2015. Updated for content on February 6, 2018. 

Posted on Oct 3, 2017

CECL Considerations for Dealerships

The ECL will be reported in current earnings as an allowance for loan and lease losses (ALLL) in your entity’s financial statements. Because this new methodology could adversely affect a BHPH dealer’s net worth on financial statements, dealers will need to factor in CECL considerations and how adjusted financial statements could impact existing bank loan covenants or other credit agreements.

Banks will be aware of potential changes among their customers, but proactive communication will be important to ensure that relationships and access to credit remain intact.

Besides big changes in accounting methodologies for RFCs, it remains to be seen what this FASB standard means for established BHPH dealers seeking future access to traditional capital. BHPH loans, by their nature, are short-term loans with a high risk of default. Dealers rely on strong relationships with financing arms to purchase inventory and maintain operations through the ebb and flow of customer transactions and variable payment plans. As banks and other third-party financing arms adopt some form of CECL model for their portfolios, they will weigh the expected risk of loans even more heavily than before — which may limit their participation in financing higher risk industries like BHPH.

Well-managed BHPH dealerships can maintain strong cash flow by keeping customers in cars, collecting payments consistently, diversifying sources of revenue and reinvesting in a variety of inventory. As we have discussed in , there are ways to improve the scale and structure of your dealership to add value to the loan portfolio. We focus on your relationship with financing, your tax returns and operational changes to improve profits.

Download the Whitepaper: The Impact of New Credit Loss Standards on the BHPH Industry

In light of this new federal accounting standard for monitoring and calculating expected credit losses, BHPH operators of all sizes will likely require additional professional support. A CPA knowledgeable in BHPH operations can help you determine the standard’s impact on your current accounting methods, monitoring and reporting. Talk to the audit group at Cornwell Jackson to start planning for internal and external finance changes in the next few years.

Mike Rizkal, CPA is the lead partner in Cornwell Jackson’s Audit and Attest Service Group. He provides advisory services, including financial audit and attest services, to privately held, middle-market businesses. Contact him at mike.rizkal@cornwelljackson.com

 

 

 

Posted on Sep 22, 2017

Analysis Required

In a June 2016 report by Big Four accounting firm PwC, it stated that each entity’s “estimate of expected credit losses (ECL) should consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments.”

The actual methodology used to calculate ECL is left up to each financial entity, so it may be that several models are tested and used in combination to assess loan portfolio risk. Again, the new methodology is an assessment of risk of future losses as opposed to calculation of actual incurred losses, so you will need to use reasonable judgments based on historic data and the nature of current contracts and customer profiles — even types of cars sold — to determine the ECL.

Let’s look at two methodologies commonly used by BHPH operators to determine portfolio value and discounts, and how these might be adjusted and work in tandem to support the new standard:

Vintage Analysis

Vintage analysis is based on loss curves that include expectations of losses at each point in the life of a financial asset. Under the CECL model, dealers would look at the remaining area under the loss curve rather than one point of time on the loss curve. Dealers can use vintage analysis to report expected credit losses on the remaining life of the assets in their portfolio. This calculation can then be measured against a baseline of portfolio performance.

Static Pool Analysis

A baseline of portfolio performance — that is, historic performance — must be established in order to forecast expected losses. Using a static pool concept, you collect data on common risk characteristics within existing segments or classes of loans. Using origination dates by same month, quarter or year will help you develop a pool that can be tracked for lifetime of loss. By looking back over several years of origination and collection data, you will develop a stronger baseline to support implementation of the CECL and recording a risk-focused ALLL on your financial statements.

Continue Reading: Other Considerations Relating to CECL

In light of this new federal accounting standard for monitoring and calculating expected credit losses, BHPH operators of all sizes will likely require additional professional support. A CPA knowledgeable in BHPH operations can help you determine the standard’s impact on your current accounting methods, monitoring and reporting. Talk to the audit group at Cornwell Jackson to start planning for internal and external finance changes in the next few years.

Mike Rizkal, CPA is the lead partner in Cornwell Jackson’s Audit and Attest Service Group. He provides advisory services, including financial audit and attest services, to privately held, middle-market businesses. 

Contact him at mike.rizkal@cornwelljackson.com.

Posted on Sep 12, 2017

BHPH dealers may need to consider data collection in ways they haven’t before, or ways of collecting data that weren’t required before, to develop forward-thinking estimates of credit loss.

For example, our clients will often review data on all the loans issued in a given month, and then analyze how those loans are performing as a gauge of how all loans are performing for the year (static pool analysis). They might see that 10 percent of loans defaulted in the first six months and another 10 percent defaulted in the next six months. Using that static pool of loans, the dealers will then calculate a discount rate before selling the portfolio to the RFC.

With the new standard, tracking average default rates for a short time period is not enough. Analysis will have to go deeper to determine “potential loss” over the life of loans. The final risk-based calculation will be reported in the dealer’s current earnings as an “Allowance for Loan and Lease Losses (ALLL)” on financial statements.

If the ALLL increases — as many think it will under this new standard — it will impact the net worth of a financial institution on its financial statements. That’s why it’s so important to collect the right data and make sure it is accurate. Incomplete or inaccurate historic data — such as data that has not historically been audited — will affect the accuracy of the final calculation

Operators may need to track data such as expected timing and extent of projected cash collections of the loan portfolio as well as projected losses and an estimate of future principal losses. In order to estimate future losses, it may also be helpful to track:

  • Actual cash value and type of vehicle sold
  • Customer risk assessments, including credit scores
  • Underwriters approving each contract
  • Collectors assigned to which loans
  • Loan performance data

The level of risk estimated also correlates to the amount of cash reserves an entity may be required to hold to support these expected losses over the life of the loan portfolio. Known as your entity’s “reserves for credit losses,” this amount may need to increase under the new accounting standard if you find that “expected credit losses” over the life of the loan portfolio are higher than the real incurred losses that previously guided reserves.

Continue Reading: CECL and Loan Portfolio Analysis

In light of this new federal accounting standard for monitoring and calculating expected credit losses, BHPH operators of all sizes will likely require additional professional support. A CPA knowledgeable in BHPH operations can help you determine the standard’s impact on your current accounting methods, monitoring and reporting. Talk to the audit group at Cornwell Jackson to start planning for internal and external finance changes in the next few years.

Mike Rizkal, CPA is the lead partner in Cornwell Jackson’s Audit and Attest Service Group. He provides advisory services, including financial audit and attest services, to privately held, middle-market businesses. Contact him at mike.rizkal@cornwelljackson.com

Posted on Sep 5, 2017

Following the global financial crisis of 2007 and 2008, the Federal Accounting Standards Board (FASB) has taken steps to mitigate risk among financial institutions. One of the newest standards is a change from the “incurred loss” accounting model used to evaluate financial portfolios to an “expected loss” model known as the Current Expected Credit Loss model (CECL). For BHPH dealers, CECL will require changes in loan and lease loss recording, which in turn requires changes in the type of loan data collected and how it’s analyzed. This article outlines what BHPH dealers can do to prepare for this sweeping change and why it’s important to start planning now.

At a recent TIADA conference, BHPH dealers and related experts were discussing the impact of the Current Expected Credit Loss (CECL) model on their industry.

New Credit Loss Standards

CECL was announced in 2016 as part of a new Federal Accounting Standards Board (FASB) update, and it “represents the biggest change to bank accounting ever,” according to Mike Gullette, vice president, Accounting and Financial Management, for the American Bankers Association. The implementation deadline is by 2021 for all financial institutions. The deadline for SEC filers is 2020, and these entities will likely set a course that non-SEC filers will use to develop their own standards methodology.

This new standard impacts any financial entity with the following assets, including Related Finance Companies (RFCs):

  • assets subject to credit losses and measured at amortized cost;
  • certain off-balance sheet credit exposures, including
    • loans
    • held-to-maturity debt securities
    • loan commitments
    • financial guarantees
    • net investments in leases
    • reinsurance and trade receivables.

In essence, CECL is designed to make financial institutions examine the future risk to their portfolios, not based on actual incurred losses in the portfolio but on expected loss. This expected loss isn’t reliant on annual loss rates, but on expected “life of loan” data or life of portfolio loss rates.

In future blog posts we will drill down on some immediate impacts to the BHPH industry — specifically on loan portfolio data collection, analysis and loan covenant considerations.

Continue Reading: Current Expected Credit Loss Model and Data Collection

In light of this new federal accounting standard for monitoring and calculating expected credit losses, BHPH operators of all sizes will likely require additional professional support. A CPA knowledgeable in BHPH operations can help you determine the standard’s impact on your current accounting methods, monitoring and reporting. Talk to the audit group at Cornwell Jackson to start planning for internal and external finance changes in the next few years.

Mike Rizkal, CPA is the lead partner in Cornwell Jackson’s Audit and Attest Service Group. He provides advisory services, including financial audit and attest services, to privately held, middle-market businesses. Contact him at mike.rizkal@cornwelljackson.com

Posted on May 31, 2016

BHPH Bad Customers

There are two schools of thought when creating cash flow for a buy here pay here auto dealership. One involves selling cars as quickly as possible and repossessing them just as quickly. The other more viable option is to focus on customer service. By keeping customers in a vehicle longer, the dealer can also secure steady cash flow and support repeat customers as well as referrals. Dealers, collections staff and service technicians are all involved in the customer experience. This article reviews the benefits of a customer-centric approach to cash flow and financial management and the tools that help dealers achieve more profitable payment streams.

Build in Safeguards for Bad Breaks with BHPH Bad Customers

Not every customer will respond positively to improved customer service at a buy here pay here dealership. There will be times when some customers take advantage and eventually stop paying and communicating. Be prepared for a level of default and repossession from bhph bad customers. Build that expected percentage of defaults into your budget while focusing the majority of your efforts on well-intentioned customers who need the option your dealership offers.

Don’t assume it’s a customer issue until you explore the situation. If collections start to dip, check in with collections staff to make sure they are reaching out to customers regularly, assessing the situation and discussing payment options. At times, you may find that collections outreach is inconsistent; that is an internal operations issue rather than a customer issue. Check the call logs to determine where and when the communications process is breaking down. It may also be a matter of how collections staff are communicating with customers. In this case, you will need more training around appropriate or scripted conversations that support a positive customer response and cooperation. Collections conversations about repossession are very different than conversations that encourage a customer to get current on payments.WP Download - BHPH Customer Service

If your staff is unable or unwilling to work in this new model, it may be easier to replace staff and promote “new management” to encourage more customer interest and communication. This includes anyone who will interact with customers. The longer you wait to reeducate staff and get customers talking, the more likely you will lose the payment stream and deal with more repossessions.

Slower collections, however, may also reside with a dealer who is not pulling and reading reports every week — or at least biweekly. If the dealer doesn’t have the time to pull and review reports regularly, assign a back office team member to the task who can pull reports and summarize findings.

 

One important factor for achieving regular payment streams is how the payments are set up in the first place.

Customers in buy here pay here arrangements typically make weekly or biweekly payments, sometimes in person. Payments should be set up according to how the customer gets paid, which is usually weekly or every other week. For other customers, their income can change during the year. It’s much easier to handle a collections issue later if you are aware of how the customer gets paid, what could hinder the customer from paying and how you will resolve a cash flow issue on the customer side if and when it happens.

Meet with your CPA every month or quarter to gain insight on reporting and budgeting improvements as well as cash flow projections for the dealership. Your CPA will not make customer service calls for you or force you to design and read more accurate reports. But we can make sure the software is set up properly to provide up-to-date and helpful reports. CPAs familiar with buy here pay here can also identify the information dealers should pay attention to in a customer-centric environment.

Dealers will still have to repossess vehicles even with good customer service. So why make the switch? The simple answer is that valuation of the dealership is tied to strong collections, a well-performing loan portfolio and healthy margins. Lenders and investors consider these areas of the operation carefully when deciding to extend credit. At least one investment group we know of required a dealer to switch to the customer-centric approach as a way to improve cash flow.

If you think this approach could work better for your dealership in the long run, talk to the auto dealership team at Cornwell Jackson.

MR HeadshotMike Rizkal, CPA is the audit and assurance partner in Cornwell Jackson’s assurance practice and auto dealership segment. Mike utilizes his real world practical experience to provide consulting and accounting services to buy here pay here owners and managers across North Texas.