2015 has been a year of growth for the motor industry. Sales increased 30% year-on-year, the second consecutive year of strong growth in the sector, and new car sales surpassed 100,000 for the first time since 2008. In addition, given the number of positive forward-looking indicators, it appears that the motor sector will continue to enjoy this growth period for 2016.
In this article, we discuss the current state of the Irish motor sector and also consider how dealers can ensure this growth period is also a profitable one.
Current state of the Irish motor sector
The period January to November (inclusive) has seen a 30% year-on-year increase in total passenger car sales, according to SIMI. In fact June was the only month this year in which sales were lower when compared with the same period in 2014, which highlights the adjustment in consumer behaviour to the bi-annual registration system. Furthermore 2015 has been the best year since 2009, as illustrated in the chart below:
Despite the momentum in sales over the past two years (i.e. since the start of 2014), 2015 sales still lag behind 2007 and 2008 levels (see chart above, right). With the average car on Irish roads over eight years old, combined with a strong economy and good credit conditions for consumers, there is capacity for further growth in the motor sector. Industry experts are anticipating that sales could potentially reach 150,000 in 2016.
Reviewing your business’ performance
In a growing environment it can be very easy to fall into the trap of chasing high top-line figures without this translating through to your bottom line. It is therefore important that dealers have a grip on their finances to capitalise on profitability. Conducting a review of your business can tell you how you have performed during this current growth period and how you can factor this into your 2016 budget.
Analysing your profit and loss account
In reviewing your profit and loss account over recent years, your business’ performance should be illustrated through a series of Key Performance Indicators (KPI’s). These will tell you how your business is performing against prior year; against budget and also, through SIMI’s industry statistics, against the industry as a whole.
KPI’s could take the form of, for example, sales growth percentage and also look at margins such as: gross profit margin; Earnings Before Interest, Taxation, Depreciation and Amortisation (EBITDA) margin, EBIT margin, profit before tax percentage and profit after tax percentage. It is subsequently through the explanation of variances against budget, prior year and industry, that you will understand what is driving your business’ performance. For example a KPI may show that:
- revenue has increased 35% year-on-year, surpassing budgeted figures and implying that your business is outperforming the market. This is great news, right? Well maybe not. Another KPI may show that gross profit margin is not being maintained. A discussion with your management team may highlight that you have been overpaying for used cars or trade sales, or that your salesmen at the forecourt are offering too high discounts to push through sales. A solution to this may be to examine what policies you have in place to ensure sales discounts do not exceed a certain level and translate this through to sales commissions should limits be breached. Having policies and limits in place for buying used cars and
trade-ins will ensure your cost of sales is not the factor impacting gross profit margin;
- EBITDA margin is not being maintained. Investigating operating expenses may show that wages and salaries have increased disproportionately against growth for the overall business or that your business’ marketing spend is not providing a sufficient return. The solution may be to look at productivity and cost rationalisation in the area of payroll and also to conduct a review of what marketing channels are being utilised to promote your business; and
- interest costs are having a strong negative impact on your business’ bottom line. A review of your debt obligations may highlight that you do not have the appropriate debt mix (i.e. too much short-term debt, permanently in overdraft). A solution to this may be to look at refinancing debt, or perhaps turning your overdraft into a term loan at a lower rate of interest.
Once you have analysed how your business has performed, then you can build such performance into your 2016 budget and be fully aware of what risk areas may hinder your growth plans.
Analysing your balance sheet
This should including a thorough review of your working capital management policy. Such analysis will indicate if your business has the resources required to support the forecast growth. Insufficient working capital resources (i.e. not having enough cash or not having access to credit) may negatively impact margins (i.e. by driving up interest costs) as well as creating liquidity risks (i.e. should there be an unexpected withdrawal of credit).
To measure the efficiency of your working capital management, you may consider calculating your cash conversion cycle and reviewing how working capital is being funded. A thorough review will indicate:
- slow moving stock – are stock levels not moving as quickly as they should be. Higher stock turnover will translate into better cash flow for your business, assuming operating profit margins hold constant. Failing to have the right stock to match consumer appetite will result in low inventory turnover, thereby negatively impacting cash flow. A pragmatic approach to slow moving stock may be to look at emerging trends and channel your used car purchases to match such developments;
- how your business’ finances have coped with unforeseen demand (for example, did your business use short-term financing to take advantage of a surge in demand in 2015 or was there sufficient stocking loans in place?);
- whether you have structured your business’ finances to deal with the new two-peak sales season (for example, how efficient and accurate was your business’ management of inventory?); and
- is your business over-reliant on one source of finance to fund its working capital. If so, you may need to consider diversifying.
Examining your business’ working capital management policy and efficiency over the past 12 months will indicate what resources are needed to be committed for the coming year to support growth forecasts, which can then be factored in to your 2016 budget.
Analysing cash flow
Cash is the lifeblood of any business. That principle may have seemed more important during the height of the recession when dealers had greater cash flow pressures to service fixed costs. Nonetheless, the efficiencies learned during the recession should not change despite strong growth since 2014. If businesses are maintaining margins and managing their working capital efficiently, then this will translate through to cash flow, thereby allowing you to reinvest and expand your business.
Sales levels are forecast to grow for a third year in a row for 2016 and some industry experts are predicting sales of 150,000. Should this happen, it will mark a 17% year-on-year growth and equal 2008 levels. As dealers try to capitalise on this growth period, we recommend a tight grip be kept on management of your business’ finances and primarily cash flow. In a cyclical industry with tight margins, such as the motor industry, embracing cash flow management will put your business on a sustainable platform for long-term growth.