What's More Important Than Consolidation and Wage Wars? Cash Flow

Nov. 15, 2018

We are entering a very unique time in the tire and automotive service industry. For this column, and to paint a clear picture, I must be brief and vivid. Let’s break down the current and upcoming landscape.

First to impact us is the consolidation and the distribution level and major chains. At its heart, consolidation is about improving gross profits — for both tire makers and distributors. Many other things occur like efficiencies and faster processes (eventually or hopefully), but the driver to consolidate is improved gross profits. 

What this means for independent tire dealers is a squeeze on tire and parts margin, since both areas are experiencing consolidation. For dealers, margins must be protected now, and raised to acceptable levels. Dealers operating at parts and tire margins of between five and 10 points below where they should be will experience a cash crunch so severe they will find it hard to make their next purchases.

Second to hit dealers, if it hasn’t already, is a wage war.  What needs not to be explained to any shop owner is the availability of talented technicians, and employees entering the shop for the first time willing to stick through the difficult learning and overall shop environment to get through the first two years where most turnovers occur. 

To summarize, the industry has massive turnover on the intro level, and not enough skilled employees to meet demand. This, by natural market forces, will create a wage war. Technician pay is about to go up considerably because shops will need to capture the talent that is available to the local economy. It’s just a fact that nearly every 12- to 19-year-old for the last decade has been told that college is their only choice, which means not enough people were entering the trades. A wage war on top of consolidation puts further strain on cash.

Third to impact the industry is technology. Lane warning systems, LIDAR (light detection and ranging), crash avoidance, and a host of other technologies will quickly push alignments from the traditional $89 to upwards and in some cases well over $1,000.  This will require a massive upgrade in technology, another shot to cash flow. 

In previous articles I’ve already mentioned basic technology upgrades that are soon to be required, like DVI (digital vehicle inspections), machine-to-machine communication in the shop, and others. Small business owners not in a position to invest heavily in the main assets of their company, their people and their equipment, will radically fall behind and find it nearly impossible to catch up.

Why all the doom and gloom? Well, most importantly, this isn’t doom and gloom. This is an opportunity to professionalize the industry. This is a much needed punch in the arm for businesses that are prepared to up their game, which will allow them to compete on a whole new level. It’s not doom and gloom because this is awesome. Change is always difficult, but change is constant now. We should be seeking the most cost effective way to adapt. It’s no longer OK to resist. And that’s fantastic.

What is a paradigm shift? A paradigm shift is a fundamental change in the way an industry does business. It’s a process that at first doesn’t seem like a big deal, but like a sneak attack can be a major disrupter. Think the electric guitar. Personal computers. Cell phones. Digital film. Nobody laments the demise of the typewriter repairman. Nobody complains that there are no public phones anymore.

The next question is, “How do you prepare for what is to come?” Well, for starters, cash flow needs to be on the front mind of every owner. Cash flow is not net profit, although net profit fits into cash flow. Cash flow is what happens to your cash after the company produces net profit (the extra cash left over from sales minus the cost of goods sold and expenses). Any net profit goes into a cash flow account, from which the company pays for taxes, floats accounts receivable, buys the next shipment of tires, pays down the principle of its loans, and invests in the facility (new equipment) and its people (pay raises and training). Without net profit, a company can exist for several years. Without cash flow, the company is bankrupt and the government shuts you down, pays itself, then your creditors. Game over.

Many small business owners often wonder, “I made a net profit last month, why doesn’t my bank account have that money?” Cash flow is the reason. A Profit & Loss Statement (P&L), which shows net profit, doesn’t state the cash position of the company. A P&L only indicates how much profit was made during the regular business of the company at a specific time, which in our case is selling tires and automotive service. P&L’s do not include the movement of cash around the company.

Besides fending off bankruptcy, having positive cash flow is important for many reasons. A bank, if you want to borrow money, will want to see your cash flow. If your cash flow is too restricted, the bank won’t lend you money for the new alignment machine. Or anything else. The bank wants to see healthy cash flow, because that will prove to them you can make your payments. No cash flow?  No money. That means no loan.

A simple example of cash flow struggles would look like this: A business starts with $25,000 in cash and makes $50,000 in net profit at the end of the year. That gives the business $75,000 in cash. After paying taxes, new inventory, principle loan, and other items, the business is left with, say $10,000 in available cash. Let’s say the company does the same volume of business the following year. But since there is only $10k to start, the end is $50k in net profit plus the $10k in cash. Last year we had $75k in cash. Now we have $60k. The following year, if the business remains flat, available cash flow would decrease to 45k. If something doesn’t change, this company will go broke. Out of business.

Why managing your cash flow is so important to your business

Here’s an example of what can happen if your net profit remains stagnant and your expenses are too high. Assuming nothing changes, eventually cash flow, and your business, will disappear.

  Year one Year two Year three
Cash $25,000 $10,000 -$5,000
Net profit $50,000 $50,000 $50,000
Total cash flow (cash + net profit) $75,000 $60,000 $45,000
Additional expenses* $65,000 $65,000 $65,000
Available cash the following year (cash flow minus additional expenses) $10,000 -$5,000 -$20,000
*taxes, tire shipments, paying down loan principle, investment in a facility and people, floating accounts receivable also fall into this category.      

Prepare your cash flow now. Not tomorrow, not next time, not eventually. Raise your labor rates. Increase your parts margins, and manage payroll accordingly. Be a leader confident that you are preparing your company for the future.  Don’t be the captain of the Titanic. The paradigm shift has already started. There is a fundamental change to the way we do business in tire and automotive, and it’s going to cost money to survive and thrive. There’s plenty of time to get prepared, but only if you start now.

I’m looking forward to the next five years, as we see hundreds of changes coming at this industry. It will be an incredible time to be a part of the evolution, and exciting to see who will rise to the challenges and accept the responsibilities to be leaders of small businesses.

Dennis McCarron is executive director of Dealer Strategic Planning Inc., a company that manages multiple tire dealer 20 Groups in the U.S. (www.dsp-20group.com). To contact McCarron, email him at [email protected].

About the Author

Dennis McCarron

Dennis McCarron is a partner at Cardinal Brokers Inc., one of the leading brokers in the tire and automotive industry (www.cardinalbrokers.com.) To contact McCarron, email him at [email protected].