How to Manage Inventory Financing Effectively
In the automotive industry, managing inventory is one of the most significant challenges dealerships face. Floor plan financing offers a solution by providing the funds needed to stock vehicles, allowing dealerships to maintain a diverse and appealing inventory without tying up too much capital. However, to ensure long-term success and optimize cash flow, it’s essential that dealership accounting teams understand how to effectively manage floor plan financing.
In this blog post, we’ll explore what floor plan financing is, its importance to dealership operations, and best practices for managing it efficiently to avoid common financial pitfalls.
What is Floor Plan Financing?
Floor plan financing is a type of inventory financing used by dealerships to purchase vehicles from manufacturers or wholesalers. Rather than paying for the vehicles upfront, dealerships borrow funds from lenders (often banks or financial institutions) to cover the cost. These vehicles are then held as collateral against the loan, and the dealership repays the loan over time as the vehicles are sold.
Floor plan loans are usually structured as revolving lines of credit, meaning dealerships can borrow funds up to a set limit and repay the loan when vehicles are sold, allowing for a continuous inventory replenishment cycle.
Why Floor Plan Financing is Essential for Dealerships
Maintaining a robust inventory is crucial for attracting customers and closing sales. Without floor plan financing, dealerships would need to pay for their inventory upfront, which could strain cash flow and limit the variety and number of vehicles they can offer. Here’s why floor plan financing is critical:
- Increased Inventory Flexibility: Floor plan financing allows dealerships to stock more vehicles and maintain a diverse inventory, which leads to higher sales potential.
- Cash Flow Optimization: Instead of using large amounts of capital to purchase vehicles outright, dealerships can use floor plan loans to spread out costs over time, preserving cash for operational expenses and growth opportunities.
- Competitive Edge: Having a well-stocked and diverse inventory gives dealerships a competitive edge in the market. Floor plan financing makes this possible without depleting cash reserves.
How Floor Plan Financing Works
Floor plan loans function similarly to a line of credit. Here’s a basic overview of how the process works:
- Purchasing Inventory: When a dealership buys a vehicle from a manufacturer or wholesaler, the lender pays the supplier for the vehicle.
- Holding Period: The dealership holds the vehicle as part of its inventory, and it accrues interest on the loan until the vehicle is sold. The longer the vehicle sits on the lot, the more interest the dealership will owe.
- Selling the Vehicle: Once the dealership sells the vehicle, the proceeds from the sale are used to pay off the loan for that specific vehicle, including any accrued interest. The remaining profit goes to the dealership.
- Replenishing Inventory: With the loan repaid, the dealership can purchase additional vehicles, using floor plan financing to repeat the cycle.
Managing Floor Plan Financing Efficiently
While floor plan financing provides many benefits, it can also become a financial burden if not managed properly. Excessive interest costs and carrying fees can eat into profits, especially if vehicles remain unsold for extended periods. Here are strategies to help dealership accounting teams manage floor plan financing efficiently:
Monitor Inventory Turnover Rates
The longer vehicles sit on the lot, the more interest the dealership pays, reducing overall profitability. To minimize interest costs, dealerships should aim for a high inventory turnover rate.
- Best Practice: Regularly review inventory turnover rates and focus on moving aged inventory. Consider offering incentives, discounts, or special promotions to move slow-selling vehicles before carrying costs escalate.
Track Interest and Fees
Floor plan loans often come with interest rates and fees that can add up quickly, especially if vehicles aren’t sold within a reasonable timeframe. It’s important to stay on top of these costs to avoid surprises.
- Best Practice: Use accounting software to track interest expenses associated with each vehicle. This will give you a clear picture of which vehicles are costing the dealership more in carrying costs and help prioritize their sale.
Maintain Open Communication with Your Lender
Establishing a strong relationship with your floor plan lender is critical. Lenders can offer flexible terms, adjust credit lines, and even extend payment deadlines if necessary. Keeping the lender informed about your inventory needs and sales performance can help you negotiate better terms.
- Best Practice: Schedule regular check-ins with your lender to discuss any potential changes to your loan terms. Being proactive can prevent issues like unexpected fee increases or cash flow challenges.
Create a Plan for Aged Inventory
One of the biggest risks with floor plan financing is holding onto aged inventory for too long. Vehicles that sit unsold can accumulate interest costs, reducing profitability. Establishing a clear plan for handling aged inventory can mitigate this risk.
- Best Practice: Set specific timeframes for when aged inventory needs to be addressed. For example, after 60 days on the lot, vehicles should be discounted or included in special promotions. After 90 days, consider wholesale options to clear space for new inventory.
Align Sales and Inventory Management
Effective management of floor plan financing requires strong communication between sales teams and the accounting department. Sales teams need to be aware of which vehicles have the highest carrying costs so they can prioritize selling those vehicles first.
- Best Practice: Provide regular inventory reports to sales teams that highlight vehicles with high interest costs or extended time on the lot. This ensures that sales strategies are aligned with cash flow optimization goals.
Review Floor Plan Limits Regularly
Dealerships should regularly review their floor plan limits to ensure they aren’t overextending themselves. Overborrowing can lead to higher interest costs and put the dealership at risk of running into cash flow problems.
- Best Practice: Conduct quarterly reviews of your floor plan limits and adjust them as needed based on sales performance and current inventory levels.
Impact of Floor Plan Financing on Cash Flow
Properly managed, floor plan financing can significantly improve cash flow. By allowing dealerships to finance inventory instead of paying upfront, more cash is available for day-to-day operations, marketing, and potential expansion. However, if not carefully managed, floor plan interest costs and fees can erode profitability and create cash flow challenges.
Here’s how effective floor plan management can optimize cash flow:
- Reduce Interest Expenses: By minimizing the time vehicles sit on the lot, you reduce the interest expenses associated with holding inventory.
- Free Up Capital: Financing inventory allows you to preserve working capital for other areas of the business, such as staffing, facility improvements, or marketing initiatives.
- Improve Profit Margins: When carrying costs are low, profit margins improve. Effective floor plan management means you’re paying less in interest and making more on each vehicle sold.
Floor Plan Financing as a Tool for Success
Floor plan financing is an invaluable tool for dealerships, enabling them to maintain a healthy and diverse inventory without tying up all their capital. However, to maximize its benefits, it’s critical to manage the financing process efficiently. By monitoring inventory turnover, tracking interest and fees, and aligning sales strategies with inventory management, dealerships can optimize cash flow and maintain profitability.
Understanding how to leverage floor plan financing properly ensures that your dealership can grow, remain competitive, and keep cash flowing smoothly. By following the best practices outlined here, your accounting team can help the dealership strike the right balance between maintaining inventory and managing costs effectively.
