Just like when the doctor warns you about your cholesterol, I’m here to warn about the silent killers lurking in dealership financial practices. Problematic dealership accounting practices aren’t new; they can happen to anyone and keeping them at bay will keep the doctor a way.
Silent killers often remain unnoticed or undiagnosed until they reach a critical or life-threatening stage, making them particularly dangerous due to their lack of obvious symptoms. My aim here is to make these symptoms more obvious by outlining proactive management and preventive measures to mitigate their threat and support an organization’s long-term health and well-being.
Problematic dealership accounting practices are silent killers.
I’ve seen a lot of bad things that end up costing dealers and dealerships a high price, and often a lot more than just money. I’ve seen every scenario from hundreds of thousands of dollars lost to people quietly being asked to resign, outright quitting when the accountability heat was turned up and even some bestowed with ankle bracelets or an unplanned trip to the graybar hotel.
I’ve seen a sales manager approve a panel van deal to a houseless person, when it was clear the person could not pay the payments or even fully comprehend the process. The only way the deal was unwound was because the bank called the references on the app and one of them said, “OMG, you didn’t sell her a car, did you??”
I was once hired to figure out why a dealership was chronically short of cash, only to find out that $5 million was still due from banks for vehicles sold 18 months prior. The dealership’s finance manager and I began dialing for dollars and were able to collect all the monies due within a few weeks.
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A clean operation, including clean books, keeps silent killers at bay.
Are there a lot of dealers who know and respect the importance of keeping clean books? Absolutely.
Are there some who, for a myriad of reasons, don’t exhibit behavior that would lead you to believe they value the importance of keeping track of the money? Yes. And I’m not here to judge them; I’d actually like to help them.
There is something pretty cool that happens when the books are straight, operations is humming along and customers are happy. It’s called peace of mind. The car business is hard enough without adding more reasons for higher stress and lack of sleep.
In dealership operations, several accounting practices can be considered harmful or unethical – silent killers – impacting both the financial health of the business and its reputation.
The following are 7 silent killers within dealership accounting practices that I’ve witnessed more than a few times. The insidious nature of these silent killers highlights the importance of early detection.
1. Not Balancing the Bank Accounts
This is the first thing I ask when I work with clients: “Are your bank recs up to date?”
Failing to reconcile a business bank account can lead to several negative outcomes, each with significant repercussions for the financial health and operational integrity of the business. The following are some of the key consequences:
- Inaccurate Financial Statements:
- Explanation: Without regular reconciliation, discrepancies between the bank’s records and the business’s accounting records typically leads to inaccurate financial statements.
- Impact: This misrepresentation can mislead stakeholders, investors, and management, affecting decision-making processes and potentially resulting in financial losses.
- Cash Flow Problems:
- Explanation: Unreconciled accounts cause misrepresentations of the business’s actual cash position, leading to poor cash flow management.
- Impact: This can result in overdrafts, bounced checks, and an inability to meet financial obligations on time, which could harm the business’s credit rating and relationships with vendors.
- Fraud and Embezzlement:
- Explanation: Regular reconciliation identifies any unauthorized transactions or fraudulent activities.
- Impact: Neglecting this task provides opportunities for fraud or embezzlement to go unnoticed, leading to significant financial losses and legal complications.
- Missed Errors:
- Explanation: Errors such as bank mistakes, duplicate entries, or accounting inaccuracies are often caught during the reconciliation process.
- Impact: Failing to reconcile allows these errors to persist, compounding over time and making it difficult to correct them later, which affects financial statement accuracy, tax reporting and can actually become very large sums of money to write off.
- Tax Compliance Issues:
- Explanation: Accurate and timely reconciliation ensures that all income and expenses are properly recorded and reported.
- Impact: Inaccurate records lead to incorrect tax filings resulting in penalties, interest charges, amended returns and potential audits by tax authorities.
2. Lack of Dual Control
Dual control is a system of internal controls designed to enhance the security and accuracy of financial transactions within the accounting office. This control requires two authorized individuals be involved in the processing, approval, and execution of key financial activities.
The main components of implementing dual control include:
- Segregation of Duties:
- Explanation: Tasks are divided among multiple employees so that no single individual has control over all aspects of a financial transaction. For example, one employee might initiate a payment, another approves it, and a third disburses the funds.
- Authorization and Approval:
- Explanation: Financial transactions, such as issuing checks, processing payroll, or transferring funds, must be reviewed and approved by at least two authorized individuals.
- Example: A payment exceeding a certain threshold might require the signatures of both the GM and the CFO.
- Access Controls:
- Explanation: Access to financial systems and sensitive information is restricted and requires multiple layers of authentication and approval to ensure only authorized personnel can make changes.
- Example: Access to the payroll system might require credentials from both the HR manager and the controller.
The absence of dual control within the dealership accounting office can create significant financial challenges and difficulties. Here are the specific ways it impacts financial stability and security:
- Increased Risk of Fraud and Embezzlement:
- Explanation: Dual control requires that two individuals approve or execute a transaction, reducing the opportunity for a single person to commit fraud.
- Example: Without dual control, an employee with access to both the company’s bank accounts and accounting system could divert funds for personal use without detection.
- Errors and Mistakes Going Unnoticed:
- Explanation: Dual control acts as a check and balance system, where one person’s work is reviewed by another, helping to catch and correct errors.
- Example: An incorrect entry in the financial records might go unnoticed without another person reviewing and verifying the transaction, leading to inaccurate financial statements.
- Lack of Accountability:
- Explanation: When tasks are performed by a single individual without oversight, accountability is diminished.
- Example: If an employee processes payments without supervision, there is no one to hold them accountable for ensuring accuracy and adherence to policies.
- Compromised Financial Integrity:
- Explanation: Dual control helps maintain the integrity of financial processes by ensuring that no single individual has unchecked authority over transactions.
- Example: In a scenario where only one person handles all aspects of payroll, there is a risk of fictitious employees being added to the payroll for fraudulent purposes.
- Loss of Internal Controls:
- Explanation: Effective internal controls are crucial for safeguarding assets, and dual control is a fundamental component of these controls.
- Example: Without dual control, it becomes easier for unauthorized transactions to be executed, such as unauthorized purchases or payments.
- Difficulty in Detecting and Investigating Fraud:
- Explanation: Dual control creates a paper trail that can be used to detect and investigate discrepancies.
- Example: In the absence of dual control, fraudulent activities may not leave a clear audit trail, making it harder to investigate and resolve financial irregularities.
- Weakened Operational Efficiency:
- Explanation: While dual control might appear to slow down processes, it actually ensures that transactions are properly vetted, leading to long-term efficiency and reliability.
- Example: Without dual control, businesses may face frequent disruptions due to the need to rectify errors and investigate discrepancies, ultimately affecting operational efficiency.
3. Improper Expense Allocation
The owner’s or GM’s personal expenses are sometimes improperly allocated as dealership expenses. This can artificially lower profit figures and mislead stakeholders about the actual financial performance of the dealership. It’s also highly improper as it can expose the business (and the person who incurred the expense) to tax issues.
Example: The owner of a dealership is renovating his house. He instructs the controller to classify these personal expenses as business expenses, thereby reducing taxable income and misrepresenting operational costs. This action is most likely tax fraud and jeopardizes not only the dealership’s operation but the owner himself.
4. Capitalizing Expenses
Some dealerships may wrongly classify regular expenses as capital expenditures to improve profit figures. While this inflates profit in the short term, it misrepresents the financial health of the dealership over time. It also inflates the pay of those who receive a commission on net profit.
Example: A bill for $25,500 comes in for advertising a special sale this month. The GM tells the controller to “Charge it to Prepaid Advertising,” (an asset account that does not affect profit/loss) subsequently bypassing expense altogether. The GM gets paid a percentage of the store’s net profit and by not charging this billing to advertising expense, the net profit is inflated by $25,500, thereby giving the GM an unwarranted increase in pay for that month.
5. Poor Receivable Collection Process
Dealerships survive on how well they collect their receivables. Contracts in Transit, Vehicle Receivables, Incentives and Warranty Receivables are four of the largest amounts that dealerships are owed every month, often in the millions of dollars. When there is a breakdown in the receivable collection process, things can get out of hand very quickly.
Reasons for this breakdown range from lack of skills or oversight, poor communication between operations and accounting, lack of accountability, leadership failures, ongoing employee shortages, and no regular monthly review/assessment.
Example: I once worked for a dealer group who’s GM was definitely not into accountability. His finance manager was ill-equipped to handle the sudden increased sales volume that occurred when we took possession of the dealership.
Within 3-4 months, there were car deals ‘hanging on the wall’ that were uncollected, many were 90 days old. To be clear, the customers had taken delivery and the banks had not funded the contracts – Cars ‘burning gas’ and not paid for. This went on for a few more months (while I was sounding the alarm bell to ownership) and soon there wasn’t enough cash to run the store.
Then one day, the GM asked me to manufacture a spreadsheet showing how we needed more cash from the corporate office. When I refused and said, “Let’s collect our outstanding contracts in transit and you’ll have all the cash you need,” he took the papers he had in his hand and through them in my face saying, “Well, fuck you then.”
Because I was a corporate officer, and could face legal liability, I didn’t last much longer working in that environment.
The GM was eventually terminated and escorted off the premises.
6. Ghost Payrolling
This is a form of payroll fraud where a non-existent employee, or “ghost employee,” is added to the dealership’s payroll. The fraudster, who could be an insider such as a payroll clerk, manager or GM, then collects the fraudulent wages issued to this ghost employee. This type of fraud can be carried out in several ways:
- Creating Fake Employees: Adding completely fictitious names to the payroll system.
- Using Terminated Employees: Keeping former employees on the payroll after they have left the organization.
- Manipulating Work Hours: Inflating the hours worked by part-time or temporary employees and pocketing the difference.
Impact on the organization:
- Financial Losses: The primary impact is direct financial loss. The organization pays salaries and benefits to non-existent employees, draining resources.
- Eroded Trust: It damages trust within the organization, particularly if the fraud is perpetrated by someone in a trusted position.
- Operational Disruption: Uncovering and rectifying ghost payroll schemes are disruptive and costly.
- Reputational Damage: If the fraud becomes public, it can damage the organization’s reputation with stakeholders, including investors, customers, and employees.
7. Dubious Wholesaler and Vendor Relationships
Dealership sales and service managers often deal directly with vehicle wholesalers and vendors. These relationships are typically very positive for dealers and they foster benefits for all involved. Unfortunately, in certain circumstances, a manager might feel the temptation to receive personal gratuities in exchange for favoring certain vendors in purchasing decisions, sometimes at inflated prices, which harms the dealership’s financial interests.
Solution: The best way to combat this is to create an environment that deters such behavior. This is accomplished by determining which suppliers and wholesalers the dealership should do business with through a set of protocols including an approval process via a management committee. This produces a master list of approved vendors where everyone knows who they can do business with and vendor relationships flourish.
Best practice: Perform a quarterly review of the approved vendors to insure trusted relationships continue.
How Silent Killers Impact the Company and Stakeholders
- Ownership/Investors: Misleading financial statements lead investors to believe the company is performing better than it actually was. Investors lose trust and often demand drastic actions be taken to clarify any false information. Cleaning up a mess is more costly than doing it right the first time.
- Employees: Trust within the company is eroded, and employees face uncertainty and potential job losses due to the financial instability caused by these practices.
- Customers: Customer trust is negatively affected, as any scandal damages the company’s reputation and reliability.
Addressing these problematic practices is crucial for maintaining the integrity and long-term success of any dealership or dealer group. Implementing strong internal controls, regular audits, and fostering a culture of ethical behavior are crucial to keeping the silent killers from destroying the health of an organization.
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