By Thomas Goekeler, Eide Bailly
Many dealers spend most of their time focusing on the profit and loss of their dealership. While that is certainly important, without some understanding of what is in the balance sheet the dealer may not be getting a true picture of their profitability.
We are often asked by dealers to review their financial records in detail to either assist them with a specific issue, give them reassurance that controls are in place and working, or just as a periodic check-up. When we do these operation reviews, we spend most of our time reviewing the dealership balance sheet. Quite simply, this is where the bones are likely buried. The accuracy of your balance sheet is directly connected to the accuracy of your income statement.
Some common examples of balance sheet items that can distort profitability include:
- Unreconciled cash accounts
- Old and/or uncollectible accounts receivables
- Old and/or uncollectible factory receivables
- Overstated parts and used car inventories
- Improper/incorrect prepaids
- Unreconciled factory open accounts
The phrase “water in your balance sheet” refers to overstated assets or understated liabilities and includes these items as well as others. Every dollar of water represents a dollar of overstated income either in the current or previous periods. It is critical that any financial review by the dealer include a review of the balance sheet.
This balance sheet review should consist of more than looking at inventory levels and the contracts in transit balance. A thorough review of the entire balance sheet is warranted because the problems can lie in a multitude of locations. If ignored, these problems in time will lead to some very negative surprises. Unrecorded expenditures, bad receivables, overstated inventories, incorrect prepaids and unrecorded liabilities can all have the same ultimate impact. They make your profit and loss look better than it should.
Let’s look at an example related to prepaids. Assume you paid your law firm $50,000 in June for some legal work related to an employment law claim. You tell your office manager to charge this amount to prepaids and expense it out over the next six months, so the current month doesn’t look so bad. Are you sure this is happening, though? If it isn’t, your year-end profit will be overstated by $50,000.
We see this happen frequently with insurance, advertising and other expenses. Anything parked in prepaids should be for the benefit of future periods or expensed. Prepaids are one of the common areas where we see manipulation or errors. If you have employees paid on the net income of the store you may see some surprising items in prepaids.
When we perform operation reviews for clients, we review journals, schedules and reconciliations to ensure the balances are correct and to identify issues we believe need your attention. Focusing solely on the income statement can be very misleading and give you a false sense of how well your dealership is operating.
If you don’t have confidence in your balance sheet, you shouldn’t have confidence in your income statement. An operation review can give you that confidence or help you make the changes necessary to get there.
Eide Bailly a business advisory and accounting firm, helping our clients embrace the opportunities that change and innovation bring to the evolving business landscape and personal financial decisions. We offer our clients inspired ideas and solutions to tackle risk and spur growth.
Thomas P. Goekeler, CPA, is a partner and director of dealership services. He can be reached at email@example.com or 1-918-748-5024