Dealership Accounting Woes and Fixes
The Problem: Your accounting is a mess. Nothing is right. You cannot rely on any number in either your Profit and Loss statement or your Balance Sheet. The bank will no longer accept a statement from you, but rather asks for one from your accountant. And your accountant? He won’t take your financial statements either. He asks only for your bank statements, your check stubs, and a list of any new equipment you have purchased this year. He wonders why you try to do it anyway, it is so obviously wrong.
Your accounting has been this way for years. You don’t know a lot about it, but you do know enough to see that items have been misclassified, posted to the wrong accounts, not posted at all, and even posted backwards. And, no one has ever gone back to fix the errors. Your detail is full of posting descriptions such as “To fix”. And, “To fix”. “To reverse error”. And “To reverse”. It is a mess that would take a genius to figure out, and apparently, you don’t have any geniuses around to make that happen. It continues year after year after year.
When you look at your Profit and Loss, you see Cost of Sales that are greater than your sales. When I arrive, I find that first, your people have been properly accruing your flooring liability, but when they made flooring payoffs they posted that to Cost of Sales, rather than relieving the flooring liability.
When you look at your Parts Inventory, and your Accessory Inventory, you see that Parts is way low, and Accessories are impossibly high. When I arrive, I will find that your Mother, who has been doing your books for all these years, has been classifying P&A by their source: If they came from Honda, they were parts. If they came from Tucker, they were accessories. It didn’t matter that you bought batteries from Tucker, and helmets from Honda. She has never once looked at a receiving document, and her classification stood as posted.
And, when you look at your expenses, you see that you have none. “How could that be!?” you say in utter amazement. And when I arrive, I will find that whoever set up your AP vendors, has put the expense account numbers in as the offsetting credit account rather than the account number for Trade Payables. That meant that every posting to AP went in, and then came right back out of the same account. No effect whatsoever, and you end up with no expenses on your P&L. For years.
And, when I come to you with an AR aging report that shows about a million dollars over 120 days, you will first scan it with great interest, and then turn to me and ask, “Hal, where did you get this report?” And then second, you will ask “Why does it show so much?”. I will go to work, and soon discover that balances due from banks and credit unions on deals have been booked to Contracts in Transit, as they should, building a large balance due in that account. But, when the money was wired in, it simply landed in the bank account, and was never credited to AR. So, the AR balance built and built, the bank account got the money, but only the debits were recorded, and never the credits.
You look at your sales, and can’t figure out why they look so low. You knew that things are bad, but certainly not that bad. So I start digging on that one and soon find that, as a five-day-store, your office people have been running End-of-Day for only the days you were open. They never thought about the activity that was done on days you were closed, and it has never been captured. So, all the warranty work that you Service Manager did on Sunday and Monday has never been booked. The deals that were finalized on those quiet, closed days have never been reported. The ETF’s that landed on Mondays have never been entered, and the parts counter sales that happened because you opened the door for a friend have not come through.
I run End-of-Day for all the missing days, and come up with $500,000 over the past year that was never captured. Never reported. And Never recognized. I wonder what has been done in years past, but don’t have the heart to suggest that we go back and find out.
It just may be that your mother, and that high-school girl that you have in the office, just don’t have the horsepower it takes to run the accounting for your complicated business. Perhaps it was expecting just a little too much for your mom’s booking background, and the girl’s expertise with licensing, to think that they could run your office. Don’t blame them. You put them in an impossible situation. They did the best they could, and you should thank them for that. No, the fault lies with you. Not with them.
But, that matters little now. We’ve got to fix this thing. Fix it once and for all. Fix it so that for once I can get my taxes right, and more important, in these hard days, I can see exactly what this business is really doing. I can’t just look at the bank account and think I’m doing well. I have got to know. “But what”, you say. “But what do I do?”. You know that you can’t go back, even with at team of professionals, you can’t go back and do it all over again. There isn’t enough time, or money, or energy to go back and do it all over again. So, what do you do?
Back in 1973 I helped start a little freight co-op that hauled motorcycles up to Salt Lake City from LA. It worked pretty well, and grew quickly into a nice little business. At one point we wanted to expand and haul freight for a large retailer—Fred Meyer—into the Salt Lake market. It would have allowed us to fill our trailers faster, and release them that much sooner so we could get our bikes up to Salt Lake quicker.
So, we knocked on Fred Meyers door and offered our services. They liked our price, they liked our service, and they liked our equipment. But, they were big, and we were small. They were worried that perhaps we couldn’t handle their account. It wasn’t the trucks, or the men or the line-haul. It was the insurance bond, the systems to handle advance and beyond charges, the control over our payables and receivables, and the financial stability to handle large sums of money flowing through our little company. They wanted reassurance that was a legitimate business, and that we could be a bona fide partner with them in the conduct of their business.
So, they asked us for an audited balance sheet. They wanted to see, from a third-party independent professional, an objective, reliable, accurate statement of our financial condition.
OK. So we went to our CPA’s, and asked them how much it would cost to get an audited set of financials. It took a few days, but they finally came back with two numbers. The first, was a fee to audit just the Balance Sheet. That was $5,000 . The second was an amount to audit both the Balance Sheet and the Profit and Loss. That was $25,000 .
Wow. $5,000 , and $25,000 . What was the difference?
But then I thought about it. And I thought about what I had learned about accounting back in my college courses. And here is what I came up with, and exactly what they confirmed as I questioned them about the two amounts.
Real, and Nominal Accounts:
All accountants know that no matter what the P&L may say, no matter what you say you have done in sales, in margin, or in the expense section, if it doesn’t show up on the balance sheet, it didn’t really happen. Use whatever word you want: true, reconciled, confirmed, whatever—if the balance sheet is right, everything else is right. And, if the balance sheet is wrong, everything is wrong. This is a basic truth about accounting, and here’s why.
The Profit and Loss statement records actions. You can’t hold a sale in your hand. It is the process of inventory going out, and money coming in. Expenses? You can’t but an expense in a bag. Employees show up, and we give them money. The gas we put in the truck is burned up. The windows that were dirty are now clean. Action in, money out. All intangible, and we term these accounts as “nominal”, because not only can you not touch them, but at the end of the year, we are going to set them all back to zero and start counting again. We can wipe them out without a whimper. They just go away. They were here only at our pleasure, and for a limited time.
But the Balance sheet has things that you can touch. You can see them. You can hold them. And most important of all, you can count them. You say you have $100,000 in contracts in transit? Show me. If I can find only $ 80,000, I go with the $80. You say your payables are at $800,000? If I find $ 900,000, we go with the $900. That’s why we call these accounts “real”. They really are, real.
Now. Those accountants that wanted so much more money to audit the P&L? They had to have more money because they were trying to confirm actions that people and businesses had taken in the past. How do you really prove that a customer bought something? Or that a shipper actually put his stuff on your truck, and asked you to deliver it far far away? How do you do that? --you can, but it costs a lot of time and money. And somebody has to pay for that.
But the Balance sheet is different. Since those Assets, Liabilities and Equity positions are real, we can count them, and prove our count by pointing to the real, physical world. You question me? OK. Let’s go out, together, and count those parts again. You think I owe more money than I say? Show me the bills, the statements, the notices from the bank and the check that cleared there. Show me the evidence, and we will reconsider. Perhaps I did miss something. But we can both look at the evidence, and then evaluate it.
By the time we go through every account on your balance sheet, count stuff, and reconcile it to the real world, we have the truth about your business position. Without balance sheets that are based in fact, we are fooling ourselves. As a nation, and as small businesses, we must demand accurate balance sheets, at every level, if we are to chart a true course to a solid economic future.
This includes you. You have seen, time and time again, numbers that you know are not right on your balance sheet. You question them, and the bookkeeper says that she or he will have to “adjust” it. Next month it is the same, just some other account. And finally, after months, even years of this, you give up, give in, and look only at the bottom line. If that, even. Too many mistakes over too many years in too many areas. There seems to be no way out. So you live with it.
But there is a way. No, nobody has time enough to go back and redo End of Days, or research journal entries from months ago. But you can count parts, check VINs, review AR, and total AP. This is relatively short work compared to reviewing all the checks you cut last year looking for errors. The accounting term is “reconcile the balance sheet”. Any CPA office will know exactly what you mean if you ask for that.
This reconciliation process is finite, has an end, and immediately brings the business into perfect focus. As you work your way down through the accounts, balances will shift both up and down. At the end, whatever balance is unresolved is sent to the P&L as either expense, or income, and then flows back to the owner’s equity section as current earnings. Let me give you some examples.
Dealer had never reconciled his balance sheet. Never. Not in 10 years of business. I could not proceed with any analysis until this was done, so began the process. As I worked my way through the accounts the out of balance was floating around $300,000 . Up, down, back, and back again, it was out about $300,000 . I finally got the the last accounts, and there was a difference of $300,000 . Good, I thought. That $300,000 will offset my floating balance, and I am home free. Looks good. Great job.
But then, I looked again. My floating balance was $300,000 debit. And the offset to the correction now needed to finish the reconciliation was another $300,000 , DEBIT. It was Debit on Debit, and I was out $600,000 . This is not looking good.
I confirmed, and re-confirmed. Yep. Out. $600,000 debit. That meant that I would have to decrease owners’ equity by that much, and the company was effectively bankrupt. It was time to talk with the owner.
Owner was sitting at his desk. I walked in, shut the door, and said we had a problem. Told him what I had found, and asked him if there were any more assets that I had not seen. He thought, and then began to explain. He said the he had 3 partners, there were 4 of them all together, and they each had taken out about $15,000 per year in bikes, boats, 4-wheelers and parts, and this had been going on for about 10 years. I did the math. Four owners, $15,000 each per year was $60,000 per year. Ten years at $60,000 per year? Yep. About $600,000 . I had found my missing $600,000 , and it wasn’t coming back.
These guys had gutted the company, and it could no longer continue. Also, and I didn’t point this out to him, but there was a substantial tax problem when over one half million in compensation had been paid out and not 1099’d.
You can’t audit your Profit & Loss, so focus on your balance sheet. Make someone prove every number, every month. Don’t let one funny number go unchecked. Our industry is not known for having expensive, high-octane accounting people running our financials, so you have to step up and set the expectation. Do it, and get accustomed to the peace of mind that comes with knowing the truth of things.
You can never go back, find and fix all the errors of the past. Good or bad, establish the truth as it exists today, and force your records to that truth. With just hours of work, rather than months of frustration, you will finally know the truth about your financial position. Then, and only then, can you chart a course through rough waters to both survival, and success.
Reconcile your Balance Sheets.