we buy auto notes

Identifying Key BHPH Objectives and Performance Indicators

Step #8 of 27 steps to starting and managing a successful BHPH operation

Identifying Key BHPH Objectives and Performance Indicators

Step #8 of 27 steps to starting and managing a successful BHPH operation

by Jim Rhoads

Step 8? Already?! We have done nearly everything we need to do before we open the doors and start approving our own deals. It is going to be nice to be the bank. Soon, you'll be pricing cars, greeting buyers, and making loan decisions. Before we wrap up the preliminary steps with training, it is imperative that we take a moment to pinpoint some key objectives and indicators that will start us down the right path and later help us verify that we are running our buy- here business well. We can then have a much better chance to get it right from the beginning.

If you read the steps outlined in earlier issues, you know by now that I am going to urge you to keep a focus on cash flow and collection efficiency. Profit is important, no doubt. But profitability, especially early in your BHPH business life, will be the least of your challenges. Therefore, we just need to set some guidelines for deal structure to keep our gross margin or profit return in line. Let's do that last. We should first settle on indicators that will take us where we have to go in terms of achieving positive cash flow, optimizing collection efficiency, and limiting risk.

Here's your number one indicator of BHPH success: the number of paying accounts necessary to achieve positive cash flow. Let me restate that – the number of paying accounts. This has nothing to do with your portfolio size in dollars. Rather, we are seeking to establish what mark you must climb to in order to grow your bank account. This is the most critical number in any BHPH operation and every dealer should know exactly what that number is. You might recall that I explained in earlier articles that my definition of positive cash is having inflow from operations surpass the outflow associated overhead and cost of sales combined. When analyzing cash flow, I prefer to divide cash outflow into three major segments: 1) operating expenses/overhead, 2) cost of sales/inventory replacement, and 3) income tax obligation.

While your cash flow projections certainly should include a plan for income tax liability, we are not going to include it for our purposes here. We are only focusing on cash flow of the operation so we can use that information in strategizing with our management team. To do that, we must calculate the precise number of active, paying accounts we need to have on the books to generate inflow that exceeds our outflow. This is our “breakover” point. Again, this is the most important long-range figure to set your sights on. Before we move on, consider the negative ramifications of failing to achieve that mark. You know that your BHPH dealership will require an initial capital injection and that it will continue to require capital for a period of time. But I am quite sure you expect the cash to reverse flow at some point. You do, don't you?! I only ask to be clear and to make sure that you carefully examine that question and anticipate the timing of reaching a positive cash position.

All those entering BHPH should study these numbers in some detail. I have worked with some dealers who were years into business and desperately seeking capital because their operation had exceeded their cash expectations so they were still putting money into the dealership. This can happen for a few reasons, not all of which are negative. Some of these dealers who were still experiencing negative cash flow had grown massive portfolios and substantial equity, but lenders were not sufficiently impressed with the quality of the portfolio to loan the capital necessary to sustain the growth. Needless to say, this is a very uncomfortable position for the dealer to be in. By setting an account objective and holding to that plan, it is entirely possible to build a huge BHPH enterprise that is at least partially self-funded.

The number of accounts is so important that I urge clients to draft their business plan in a way that allows them to place that objective well ahead of any goal to maintain a certain average for down payment. Of course, cash is king in buy- here, pay-here and down payment does reduce risk. But, there is much greater risk in growing a BHPH operation that fails to turn positive in a reasonable time period. How much is your overhead monthly? You want your inflow to cover that soon, right? Don't get caught sitting on aging inventory, holding out for a big down payment, and watching negative cash going out for overhead month after month. There is the real risk, but it can be avoided. Looking past the down payment to the customer is the best approach. I often say that the best BHPH customers don't always have the best down payments. By approving stable customers who can make a payment, you will grow your account base and your bank deposits. In order to make that happen, you must build a cash flow plan that allows for a strategy that might run light on down payment in favor of gaining accounts.

Having dragged you through that long-winded justification for focusing on the account level rather than dollars of receivables, let me now take you back to some of that math we used in step 6. We'll keep it simple as we calculate that actual figure. Let's use “O” for overhead and “C” for cost of sales. That will take care of the outflow side. Now use “D” for down payments, “W” for wholesale sales, and “P” for payments. These cover the most common types of inflow. The resulting formula should look like this:

Downs + Wholesale Sales + Payments > Overhead + Cost of Sales or D + W + P > O + C

Now, estimate all the figures, saving payments for last. How many BHPH sales do you expect to finance per month and at what average down payment? This will obviously determine your inflow in that area. For this example, lump deferred down payments in with the down payment you expect to collect at delivery. Wholesale cash sales will create some inflow as well as your disposed of trades, aged units, and eventually repos. Include trades with down payments if you prefer. Either way, it is inflowing cash. Now jump to the outflow side. Estimate overhead. Then, estimate cost of sales being sure to add all sales related money such as reconditioning costs, starter interrupt devices if applicable, and costs associated with tax, title and license fees. Once all of these figures have been tallied, you can simply solve for “P” to determine how much payment inflow you will need to get you to the promised land of positive cash where life is good. All that remains to arrive at the number of accounts needed is to settle on a figure for average car payment. Until I explain further in a future article, I must at least urge you to keep the average payment on the moderate side … say, $275-$285 monthly or in the range of $65 per week. I make this suggestion to keep it reasonable based on considerable experience. Income is a factor but not the only factor. Payment amount should be carefully reviewed on a case-by-case basis. Stay tuned to the series for more detail. Once you plug in the average payment amount, you know how many accounts you'd need before you would at least have the option to stop injecting money from outside.

This exercise led you to the figure. And like most figures in your business plan, it is subject to change but its rank in importance should not change. Every BHPH dealer should keep his/her eye on that target, even if it moves from time to time.

Another critical figure in BHPH cash management is “cash-in-deal” – also referred to in the industry as the risk or exposure in each deal. It is calculated by simply subtracting the down payment and net trade amount from the total cost associated with the sold unit. It is usually expressed on a per-deal basis. This is what BHPH veterans often refer to as “money on the street.” And while the exposure is later reduced as the customer makes payments, the term “cash-in-deal” is typically used for the exposure at delivery. This is a very important figure to govern by policy and one that should be closely monitored to confirm that the average remains “on plan.” Routinely exceeding the cash-in-deal limit in place at your dealership translates to excessive capital consumption and a potentially hazardous deviation from the business plan. Seller beware! Regulating cash in deal is simply a matter of holding managers accountable to the underwriting/approval procedure and maintaining sufficient outside controls to ensure that exceptions are justifiable. Doing so will help to regulate cash flow and mitigate risk.

The indicator that ranks number three on my list is actually number one in terms of daily management. It is only listed third here since it only comes into play once payments are being collected. That indicator is what I have dubbed the Collected Payment Efficiency Ratio. This figure is the most telling when it comes to measuring a collection manager's performance, yet it is one that few dealers seem to track. I will go into considerable detail on this subject in a future article, but for now I must simply urge you to track the comparison of payment dollars collected to dollars expected. The resulting ratio indicates how well your staff is performing when it comes to banking those payments that we established will be the largest part of your vital inflow. The ratio, best derived from weekly projections, is most useful in the form of the day's month-to-date value. This is an excellent figure to write a manager's pay plan around. I have done it and it works well to keep managers focused on what matters most. Track it from the very first week of business!

A report of collection efficiency provides information that cannot be gleaned from a delinquency or recency report. Simply put, a delinquency report only shows at a certain point in time who hasn't paid and perhaps how much. Tracking the collection efficiency ratio, on the other hand, reveals how well collectors have done over a broader period of time in terms of ultimately getting the customers to make their payments. Good managers and collectors can experience somewhat inflated delinquency. By monitoring collection efficiency in addition to delinquency and recency, dealers might avoid penalizing or even dismissing managers who are doing well in the area that matters most – consistently depositing a high percentage of the expected payments in the bank.

Finally, we turn to the profit ratio that I said we would save for last. You might be surprised to learn that I am not going to suggest an emphasis on average gross per deal. While that is an interesting number, it varies too much. That number is especially erratic in dealerships offering mixed pricing/financing options. Therefore, I suggest tracking the “gross to cash-in-deal ratio.” This ratio is very similar to the rate of return ratio I covered in a prior article, but this one compares gross profit to the cash-in-deal. In other words, on a percentage basis, how much gross are you generating per deal compared to the cash exposed?

I began to examine this ratio years ago and I find it to be the most useful in verifying that the business is generating sufficient gross profit on the sales related capital placed at risk. Unlike rate of return or gross margin, the gross to cash-in-deal factors in the down payment. This is what you really want to know, especially when comparing locations or managers. How much gross are we producing for the “net investment?” Just as it is with cash-in-deal, this ratio is easily incorporated into the underwriting procedure and governed in the same way on a per-deal basis. Holding gross in buy-here, pay-here is not difficult. It just isn't. In fact, as I mentioned earlier in the series, I submit that the bigger problems dealers face can often be traced back to piling on too much gross. For this reason, I suggest tracking the gross/risk ratio to verify that it remains in a healthy range – not too low and not too high. I know you might be thinking, “But Jim, too much gross? Come on!” That is an outrageous thought to many, I know. I won't attempt to tackle that philosophical discussion here. Rather, I will just urge you to track the results in your underwriting and see for yourself. Until you can reach a conclusion on your own, just remember that there is nothing worse than paying income tax on what later proves to be “unbanked” profit.

Make no mistake friend; buy-here, pay-here is a great business. It is the most profitable segment of the car business. And when it is managed properly, it can turn those profit dollars into massive amounts of positive cash flow. To achieve the desired end result, it is only necessary to learn from the mistakes of others and avoid those hazards. By knowing the areas that are key to good management and by tracking these four valuable indicators, it is more than possible to march full speed ahead down the path to BHPH success.

In the next issue we move to training and prepare to swing the doors open on a very prosperous business venture!

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

World Of Special Finance
Click here for more information




We have been very pleased with the service we have recieved. We have closed several transactions and look forward to doing more.

-  Bowling Green, KY

Financial Solutions has really helped me grow my business.

- Memphis, TN

I have done several transactions and I am very happy with the results.

 - Kosciusko, MS

If anyone is looking to sell auto notes Russell Crosby is the guy to work with. He is very professional, honest and kind. He answered every question I had without hesitation. I recommend for anyone looking to sell auto notes to give him a chance!
Thanks Russell,
Chester Mitchell


Frazer DMS Software