Dealers need to be diligent in the operation of their stores and be decisive if there is any indication that the current trends are changing.
It’s been a wild ride of a year for industries of all kinds and automobile dealerships are no exception. From mid-March to early-June, showrooms were shut down, service and parts were operating well below capacity and many dealers made the difficult decision to cut their losses and close their stores during the pandemic’s surge. Instead of selling and servicing cars, the focus was on staffing reductions, expense cuts and Paycheck Protection Program applications. The days seemed like months and the weeks seemed like years, as dealers waited to resume operations. Fortunately, for most dealers, as the spring and summer weather approached and restrictions were lifted, business also heated up and many dealers recorded healthy profits in May and June due to a restoration of the pre-surge sales volume coupled with less staff and reduced expenses. While the industry is, in general, breathing a sigh of relief and the outlook for the rest of 2020 is certainly better than anyone could have anticipated back in March and April, there are still many headwinds that dealers need to be mindful of in the coming months. Here are just few that dealers should be conscious of:
In general dealers have yet to feel a credit crunch with customers’ financing. However, banks are being cautious with commercial credits—and while the home mortgage market is booming, lenders are being extremely diligent in ensuring customers have the wherewithal to meet their obligations. These trends, coupled with high levels of unemployment and the overall economic uncertainty, could result in future financing difficulties for customers or escalated chargeback levels for dealers.
Just like many dealers, the automobile manufacturers were shut down or restricted for several months and are now working through the process of resuming their normal operations. Many manufacturers are operating a single shift and have had to alter their processes to ensure social distancing for the safety of their employees. The result is quite simply that new vehicle inventory supply will be scarce throughout the rest of the year. While this creates opportunities for strong gross profits as the scales of supply and demand will shift, it will undoubtedly impact sales volume. Used cars will need to become a more significant part of the business, but they have their own risks.
With the scarcity of new car inventory, dealers are looking to fill empty space on their lots and meet customer demand with used cars. This focus has caused used car valuations to increase, resulting in dealers paying premiums to obtain inventory for their lots. While gross profits on used cars are strong and being aggressive in acquiring used car inventory is acceptable right now, dealers need to keep a watchful eye on their supply and their acquisition strategy. Dealers also need to be ready to scale back if the economic conditions change suddenly, customer traffic subsides and/or we are faced with another pandemic surge. The concern here is that used car valuations could drop suddenly, and if dealers have overpaid for the vehicles on their lots their gross profit on sales could quickly shift to losses.
Most dealers made rather significant staffing cuts during the height of the initial pandemic surge and have been deliberate about how they bring people back to work. Many acknowledge that they had too many employees on staff prior to the pandemic and that their recent profitability is largely due to a reduced headcount. The manufacturers have been relatively quiet about the staffing reductions and have not pushed dealers to meet their typical staffing standards during this time of uncertainty. While this has been a “win” for dealers over the past few months, dealers need to be ready for future pressure from the manufacturers to restore these positions.
While the changes to the PPP since its inception have been largely business-friendly, it is still a very complex program. Additionally, as noted above, many dealers have not restored their headcount and therefore full forgiveness may be unattainable. Perhaps the biggest frustration and disappointment with the PPP is the current tax treatment whereby no deduction is allowed for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP loan. While profits have been strong in recent months, most dealers have depressed year-to-date profits when compared to the prior year. However, within those depressed year-to-date profits are payroll, benefit, rent and utilities expenses that are eligible to be forgiven under the PPP. Thus, when adding such expenses back to the profit for the year for tax purposes, taxable income will be significantly higher than the dealer financial statement currently reflects. This is a nasty consequence of the PPP and, without a legislative fix, dealers need to understand that their 2020 tax liability may be higher than they expect.
If anything can be learned from the first half of 2020 it is that things can change very quickly. Nobody could have predicted back in March and April where we would be today, and nobody can predict where we will be in December. While there is plenty to be excited and optimistic about based on recent months, there are also many headwinds. Dealers need to be diligent in the operation of their stores and be decisive if there is any indication that the current trends are changing. At blum, our dealer services team is ready to help and works with dealerships to examine all possibilities and ensure the best results.
Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.