Comparing the Capital Commitment of Special Finance and Buy Here Pay Here Dealers

Whether you are looking at building up a special finance or buy here pay here department, both are going to require strong commitment, and certainly a large part of that commitment is capital. So what are the capital commitments for each on similar volume levels?

Whether you’re starting at zero or growing an existing operation, the cost is the same. Certainly a BHPH operation will have the larger capital commitment. We will also assume that you must start out by buying inventory and that you’re using industry data dealers supplied to Auto Dealer Monthly for the 2009 Auto Finance Survey. A dealer who desires to sell a constant 10 units per month, with a wholesale cost of $4,000, will have to invest approximately $275,000 without any consideration for operating expenses such as personnel costs and advertising. Naturally, this capital is not all required immediately.

Based on an average monthly cost of vehicles sold of $40,000, monthly static pool charge-offs as a percentage of the gross receivable of 2.08 percent (25 percent per year), an average amount financed of $9,400 on 36-month terms and monthly payments of around $360 per month, the portfolio would require investing slightly more than $100,000 by the end of the first quarter of business, another $85,000 by the end of the second quarter, and as the collections pool up, a total of nearly $270,000 by the end of the first 12 months. The cash flow would turn positive in the sixteenth month with the total return of all invested capital by the end of the thirty-second month. (Again, this does not take into consideration operational costs.)

So how does that compare to ramping up a special finance department?

Let’s again look at a 10-unit gain starting from zero. We will assume that the average wholesale cost of a SF unit will be $10,000. The average sale price will be $12,000 and by factoring in tax, tags, title, doc fees, extended service contract and down payment, the average amount financed will be $14,000. That is important because the hidden factor in a SF department is the frozen capital.

The average time to turn a retail installment contract into cash in your bank is 14 calendar days, which is significantly longer than the time it takes to fund a prime credit deal. By multiplying the $14,000 average amount financed by 10 deals per month, you would have $140,000 in contracts-in-transit. If it takes an average of 14 days to fund a deal, that represents 47 percent of a calendar month, and it also means that on any given day you would have 47 percent of your SF deals unfunded. With $140,000 in total contracts, 47 percent would equal $65,800 in contracts outstanding at any given point in time, or frozen capital.

While $65,800 represents slightly less than 25 percent of the capital required to fund a 10-deal-per-month BHPH operation, it still represents significant capital. In fact, the SF department will require more money than a BHPH operation would in the first two months of operation, so certainly to grow a SF department, a dealer must be prepared to make a cash investment in his or her business. Additionally, unlike a BHPH operation, this capital remains frozen forever, as long as there are SF contracts outstanding.

While the business model for SF and BHPH differ like day and night, both share subprime credit customers. What dealers often learn the hard way is that they are similar in another way, especially in the early months, in that a dealer must be ready to invest capital in order to sustain the business model. Over the long haul, a BHPH dealer must invest significantly more capital, but early on, many SF dealers are stunned to learn how quickly their capital is frozen. In the end, no matter which way a dealer decides to capitalize on the subprime credit market, they must be prepared to invest to grow their business.