Murphy's Law and a Catch-22

The headline in a recent USA Today said, “Geithner: Banks have capital.” In the article, Treasury Secretary Timothy Geithner was quoted as saying, “Currently the vast majority of banks have more capital than they need to be considered well capitalized by their regulators.” Another headline stated that GM was going to close 15 plants for nine weeks this summer due to a glut of inventory on dealers’ lots and an attempt to reduce costs.

The official tax season, which just ended on April 15th, came and went with a loud roar from most of our clients. Just for the record, “tax season” technically extends to October 15th each year, and for us CPAs, it seems it ends just in time for the next one to start. This year entailed more than normal tax planning and multiple discussions about income (loss) generated for financial statement presentation to finance sources versus income (loss) as presented on the federal and state income tax returns. No one wanted to pay income taxes, but still wanted to present the best possible and healthy financial statement for the banks and other credit sources. Sounds like the perfect oxymoron, doesn’t it?

This past year, most dealers struggled to make a profit or attempted to keep losses at a minimum, conserve cash and basically just stay alive. They were hit with some strange tax consequences generated by the headlines noted earlier in this article. Used vehicle wholesale prices, in most instances, were drastically reduced at December 2008 versus December 2007 due to diminished demand from customers. This resulted in LIFO income, rather than normal LIFO expense, for some dealers who had elected to cost their used inventories on the LIFO method of accounting.

This was welcomed by some dealers who had losses from operations in 2008 and were able to reduce the loss shown but maybe not pick up taxable income for 2008. For other dealers, it generated taxable income in excess of their losses, which caused them to pay income tax with cash they really couldn’t spare. New vehicle LIFO produced some very large deductions for some dealers because even though the factories produced fewer cars, they raised prices over the 2007 year-end levels. Some dealers who incurred these large new vehicle LIFO increases informed me it could not have come at a worse time. It reduces the dealership’s net worth at a time when the banks are telling them they already are not healthy enough. Murphy’s Law strikes again.

Most dealers who had built up reserves on the books from prior years had to use most of it to help reduce the dramatic losses incurred in 2008 and ended the year with zero or very little reserves to carry forward into 2009. As a result, if the economy doesn’t improve quickly, I expect dealers to post larger monthly losses in 2009, as the reserves are not there anymore to help weather the storm we are going through. This all comes at a time when banks and other financial institutions are bearing down very hard on the automotive industry and not renewing credit and floorplan lines. Murphy’s Law strikes again.

I’ve been spending a lot of time in the last six months, and still am, in discussions and planning with dealers who are very worried about the future of the automotive industry in general and are concerned about whether their franchises are going to be around a year from now. Many are doing everything they can to conserve cash flow, even to the detriment of possible future sales. There will be some who don’t have enough family money saved to help them get through to the next great business cycle, and they will close their doors as a result. They may or may not be able to help reduce the possible loss they will incur in shutting down by selling their franchises. As most of you know, “blue sky” has become a dark cloud and no longer exists for many franchises. The number of possible buyers has diminished greatly because they are conserving their cash for their existing stores to be able to survive or just don’t know if the franchises for sale will even still exist.

What is really going on? Unless the supply of money the banks are holding begins to filter into the economy, it will be a very bad 2009 for many dealers. Some dealers are looking elsewhere to invest their family money, but can’t find much out there that pays any kind of return. Most of our dealers with funds previously invested in the captive finance companies’ cash management accounts have withdrawn those funds and moved the money to local banks and into money market accounts and CDs. They can’t afford to be without that cash flow if something happens to their current floorplan source or franchise. As a result, the actual cash position has diminished in many stores and is invested in bank accounts paying very low rates of return, as compared to the floorplan rates offered by the cash management accounts. The money is available if really needed to invest back in the dealership, but it won’t be invested until the very last moment and only enough to get by at the time.

Again, as the floorplan sources see this cash “deserting” the dealerships, they have become very worried about the dealership’s capitalization and their ability to survive. The dealers are caught in a catch-22. They don’t want to leave any excess cash in the dealership if something bad happens too fast for them to react, but they also need to keep the finance sources happy enough to renew their floorplans and lines of credit needed to operate the dealerships. It is a no-win situation for both the dealers and the finance companies. I have fielded many calls in the last two months, as floorplan sources have started calling on the dealers wanting to know what happened to the cash and if it is really available to reinvest in the dealership if needed. I expect even more calls, as dealerships record their year-end adjusting entries and their net worth is adjusted on the factory financial statements to coincide with the federal income tax return.

The attitude of many finance companies lately has become very impersonal. Dealers who are normally great community leaders and contributors to the local economy are of little value to them without floorplan financing. If dealers treated their customers in this same manner, they would run customers off. If this continues, trust between the lenders and the dealers will be irreparably harmed and may never recover.

Dealers, circle your wagons, so you can survive the next “attack” on the store. Create an emergency plan now for the most conceivable thing that could happen to your dealership, and be ready to act upon it immediately if you need to. Oh, and don’t forget to allow time to keep selling while worrying about all the above.

Take care, and good luck until next month.

Vol. 6 Issue 6