I told him that it was wonderful, but I also had to tell him that it wasn’t accurate and to be prepared to pay Uncle Sam taxes on income that is not real! He then asked, “How so?” And I showed him his neglected balance sheet. He said that he never paid much attention to that financial statement anyway and that I was full of myself.
If your balance sheet is not proven monthly, you cannot believe a number on your profit and loss statement AND you have opened up the door to dealership fraud and embezzlement amongst other sins. By not proving your balance sheet on a regular basis, you are basically allowing the cash drawer, parts inventory, major unity inventory and your checkbook to be accessed by anyone who wants to.
The reality is that my dealer friend from above did not make $200,000 in net profit. After cleaning up the balance sheet for 2014, his net profit was more like $89,000. That’s a big difference. Where did the difference go? Unfortunately, it was an accumulation of years of bad accounting. Below are some tips and techniques to ensure that your dealership’s profit and loss statement is accurate now and going forward.
The balance sheet has always been an issue for a lot of dealerships. Most dealer principles are just like my friend from above — they don’t pay attention to the balance sheet. The balance sheet is your main connection to the profit and loss statement, and the management of the balance sheet is one of the most important internal controls that any dealership can implement.
It’s very common for you to have unrecognized revenue or expense “parked up on the balance sheet” that never made its way to the profit and loss or income statement. The balance sheet, if left unproven, is the perfect tool to commit fraud, theft, embezzlement, as well as poor job performance of dealership bookkeepers or accountants. Even if you don’t look at your balance sheet or prove its numbers each period, I can tell you that others are looking at it. Almost all of our banks, OEMs and floorplan companies require that we submit dealership financial statements for review on a regular basis. The balance sheet tells a lot about your dealership, and if it’s not correct, it can mean the difference between getting a floorplan increase or a line of credit cancelled.
What is the balance sheet?
The balance sheet is a statement of financial position at a point in time. It’s a snapshot of your dealership assets, liabilities and owner’s equity accounts. It’s the very foundation of accounting. The basic formula is: Assets = Liabilities + Owner’s Equity.
For a bookkeeping or accounting nerd like myself, one of the sexiest things to me in the powersports business is a proven balance sheet that represents the real world. Another thing that’s attractive to me about the balance sheet is when every number means something. Every number on the balance sheet should have a “schedule” or “list” of items that total up to or back up the number you see listed on the balance sheet. For example, if you see that your new major unit inventory is stated on the balance sheet at $500,000, you need to see a schedule or list of where all of the costs of each unit add up to that number.
Similarly, your cash balance should have a reconciliation done within your DMS or manually, where the ending number on that “bank rec” ties to the number on the balance sheet. The same goes for all of your assets and liabilities. If your accounting person or bookkeeper cannot provide the schedules or lists to you instantly, unfortunately no real accounting is taking place within your dealership, and you may have bigger issues than just a balance sheet out of whack. Do not assume that the schedules are being reconciled monthly. You must trust but verify.
How do we fix our balance sheet?
The first method that you could use to reconcile your balance sheet is expensive and very time consuming. Under the first method you basically transport yourself back in time and see what went wrong day by day, month by month and year by year. This method is as time consuming and expensive as you could imagine.
The second approach, which I call the “Hatchet Method,” is where you prove your balance sheet as of right this second, thus the name. Bust it open as of this moment and prove each account. This is my favorite approach. To execute the Hatchet Method, you need to set up a temporary account on your balance sheet. Then start at the top of your balance sheet and prove all of your accounts receivable, major unit inventory and accounts payable, including floorplan. Book any differences to the newly set up account on the balance sheet. This will take some time, but I promise it will be the best investment in your dealership’s internal control structure ever. And if you prove your balance sheet every month from here on out religiously, you can rest assured that your profit and loss statement is accurate and bulletproof. Now your balance sheet represents the real world, and it means something because each number represents reality.
On a related note make sure you document each entry that you make. For example, if you had to decrease major unit inventory to make it match the real world schedule, make a note of it. This will help you down the road.
What does the balance in my temporary account mean?
After you have made the last entry to reconcile your balance sheet, you will have a number in the temporary account that we set up to handle the reconciliation process. To wrestle with this number is beyond the scope of this blog, but I will explain the nature of the balance. First the balance will be either debit or credit. If the amount is debit, you have unrecognized expenses on your balance sheet that never made their way to the profit and loss. Therefore, your profit and loss was overstated over the years. If the balance left in the temporary account is credit, it is just the opposite and represents unrecognized profit that didn’t find it’s way to the income statement. In this scenario, you have historically understated income over the years. Either way the balance represents possibly years of errors and omissions in your financial reporting process in your dealership.
How do I explain this account to my CPA?
You have to be honest with yourself and with your CPA because it’s only the CPAs or accountants that do our tax returns. All you have to say is that you now have a proven balance sheet that is 100-percent accurate, and the balance left in the temporary account is an accumulation of accounting/bookkeeping errors. As stated from above, you will have documented the reason for each entry. You have to forgive yourselves and let sins of the past be forgiven. Your CPA will give you advice on how to handle theses cumulative differences. Your CPA is well versed in these types of things and the related IRS tax treatment.
I strongly urge you to come clean with your dealership’s balance sheet. You need to move forward and get timely and accurate financial statements. It’s only through the process of cleanup and monthly reconciliations of all balance sheet accounts where you can whole-heartedly believe the bottom line profit or loss on your income statement in your dealership. By proving your balance sheet accounts monthly, you are implementing one of the most important internal controls that your dealership has to detect fraud, theft and bad accounting procedures.
Forrest Flinn, MBA, PHR, SMS has been in the motorcycle industry for nearly 20 years and has been a true student and leader serving in various capacities. He previously worked as an implementation consultant for Lightspeed and as a general manager with P&L responsibility for a large metro multi-line dealership. Currently Forrest is the managing partner and chief visionary for a consulting firm that specializes in outsourced accounting, human resources, social media strategy, dealership operations consulting and Lightspeed/EVO training.