Deciding on a BHPH Model and Determining Capital Needs
by Jim Rhoads
Ah, the big question… how much cash will it take to fund a successful buy-here, pay-here operation? It is an important one too because this is an industry that has seen too many “profitable” dealers fail because they ran out of capital before they could achieve that critical point of positive cash flow. When this question comes up in seminars, the attendees usually get my long-winded response. You get the quick answer today. Most buy-here, pay-here start-ups will require from 250K to 750K to grow to that “turnover” point. Why the disparity? Sales volume, cash down, cost of car, etc.,etc, etc. Overhead of the operation is obviously a significant factor as well and there is a broad range when it comes to dealers' cost of operating. There are certainly plenty of dealers who choose a business plan that requires millions in capital, but there are options for those of us who are not quite that liquid. It is entirely possible to start a very successful BHPH operation with less than 300K. I have consulted dozens of start ups in several states that turned positive with capital investment in the 200s, usually in 12-15 months.
Before we go too much farther, let me clarify my definition of positive cash flow. I prefer to separate cash outflow into three basic categories: 1) operating expenses/overhead, 2) cost of inventory replacement/ sales, and 3) income tax. When I refer to attaining a level of positive cash, I am referring to achieving cash inflow that exceeds the sum of #1 and #2, overhead and cost of sales. These are the cash needs of the operation so any surplus cash beyond that is positive for the operation. Once a dealership accomplishes that, it is then possible to breathe a little easier and make choices about the appropriate use of the positive cash. Uncle Sam will definitely come calling for #3 so any well-crafted BHPH business plan should address taxes while allowing sufficient room for growth.
Now, which business model is right for you? Patience, friend – just a few more things to contemplate. I'll reserve most of the detail for a future issue, but I submit that there are exactly three indicators of a successful and efficient BHPH dealership. I encourage new clients to develop or choose a model that lends itself to a high level of performance in those key areas. The three indicators are:
1. Cash on cash return ratio. Simply put, how much gross cash inflow is created (typically annually) compared to the total capital invested or placed at risk? And when?
2. Weeks to breakout. How far into a typical contract before you begin to collect profit? This is just another perspective on exposure, often referred to in the industry as “cash-in-deal” but with the added factor of payment amount.
3. Collection efficiency. What are you collecting (typically weekly) versus what your portfolio is projected to produce over the same period.
Granted, the last one is more of a management indicator, but there are business models that are more likely to produce a sustained level of collection efficiency than others and therefore contribute to success with #1, that all-important cash on cash return.
No mention of profit? What about equity? You're right; those are not on my short list! But if you are contemplating buy-here, pay-here, don't put down the magazine just yet! Like Steve Martin in The Jerk, I know it is “a profit deal.” In BHPH, there will be profits and there will be equity. After all, the buyer is not in a position to negotiate on price. Profits in the near term will not be your challenge. BHPH start-up dealers have to keep a focus on banking what they book! And I further suggest that the profit needs to be banked sooner than later. Therefore, unless there is a short-term need for “paper profits” and/or inflated assets, I advise new clients to build a plan that mitigates risk and maximizes collected profit, especially early. These two objectives are best accomplished by keeping to the lowest possible cost of car. In the business of financing buyers with poor credit, cost of the car is Crucial with a capital “C.”
I developed some tools to aid clients in writing a pro forma to be the foundation of their business plan and later serve as a forecasting tool in managing their business. As you might imagine, I work with a lot of cash flow and profit projections. My clients are often surprised at how much impact a change such as an increase of $300 to the average unit cost can have on the projected capital needs. Consider a dealership selling 30 per month from inception at an average unit cost of $2,000. The cash flow projecting tool shows that when that average is increased by just $300, the cash required to turn positive increases by $119,891! And the time to reach positive cash is postponed by seven months!1 That is why the answer as to “how much” is not always a quick and simple one.
What is the least you could get by with? Consider this – I assisted a dealer in reaching positive cash in less than a year on just over 100K! Recently! I know what you must be thinking, but I was right there myself providing consultation from their first inquiries about the business until their last draw on the line of credit. Just over 100K invested (100 percent bank money) before they were collecting enough cash to cover overhead and replace inventory! The keys to their extraordinary success? A small but favorable market, low operating costs, and a very diligent buyer. They are now approaching one million in annual adjusted gross (net of repo losses) and expanding! As all of the weight loss commercials disclaim in the fine print, these results are not typical.
So, how should you decide your model? Should you calculate based on some financial assumptions and use that information to determine how much capital to allocate? Or will you choose a model based largely on the available cash? Like most consultants experienced with start-ups, I can help with either, but I strongly urge clients to first decide what it is that they are seeking from this investment. And are all partners or investors seeking the same thing from theirs? This is very important because the answers to these questions are the ones that help to craft a business plan that will produce the desired result.
The thing I most appreciate about the BHPH business is the flexibility. It is great to be the bank! That flexibility affords the opportunity to produce a number of very different investment results, all of which can yield excellent returns. One dealer may be seeking a quick turnaround on the cash with a need for some near-term positive cash flow. Others may be content to postpone cash back to reinvest and grow. I find one common thread with all of them, though … they all want money back! It is only a question of how much and how soon! This is why I always measure models in this business based on their cash on cash return. Let me reiterate that those returns are highest at lower ACVs.
The bottom line? Limited cash does not translate to reduced profitability and it certainly does not equate to less positive cash. When managed properly, even small buy-here, pay-here dealerships can generate enough of their own cash to be very profitable and sustain extraordinary growth.
Dealers coming into buy-here, pay-here can decide their business path in the same way they make investment choices with their financial planner. Finding the right answer usually requires a good tool for projecting cash flow and profits. Make no mistake, though … buy-here, pay-here has lots of models that are capable of generating incredible profit and outstanding cash returns!
Jim Rhoads is the president of Four R Consulting, LLC, a Texas consulting firm specializing in start-ups as well as ongoing training, consulting, and analytical services in the field of buy-here, pay-here. Contact this writer at firstname.lastname@example.org
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