Finance and Insurance - The Profit Center
I would like to make myself clear on a few items of interest before I get too deep into the sales processes at any dealership, including: automobile, recreational vehicles, boats, motorcycle, and even furniture or other big ticket items. A business has to turn a fair profit in order to stay in business. I believe that they should make this profit and use it to pay better quality employees a premium wage in order to serve you better. The financial strengths or weaknesses of any business can definitely have a dramatic effect on your customer service and satisfaction. I do not, in any shape or form, wish to hurt a dealerships profitability, as it is essential for his survival. I merely want to advise people how to negotiate a little better in order to make the profit center more balanced.
Let's get right down to this! Every dealership has a finance and insurance department. This department is a huge profit center in any dealership. In some cases, it earns more money than the sale of the automobile itself. Profits are made from many things that most buyers do not understand.
You as a consumer should understand the "flow" of the sales process to understand the profit centers that are ahead of you. Most negotiating from the consumer seems to stop after the original price is negotiated and agreed upon. Let's examine just a small portion of what leads up to that point.
The first thing that every consumer should understand is that when you go to a dealership several things come into play. One of the most important things that I could point out to you is that you are dealing with a business that has been trained to get the most amount of money from you as they can. They are trained and they practice these tactics everyday, day after day, week after week, month after month, and year after year. Let me point out a couple of important facts that I have said in this paragraph. First, you'll notice that I said a dealership and not a salesman and secondly, I emphasized times of day after day, week after week, etc. etc. This was done to let you know that the salesman is working very closely with the sales managers in order to make as much money as he can. Your interests are really not their objective in most cases.
One tactic that is used heavily in the business is that the salesman says he is new to the business. This may be true or not, however; keep in mind that he does not work alone. He is working with store management, who gives him advice on what to say and when to say it. These guys or gals are very well trained on how to overcome every objection that you may have to buying from them. They have been trained in the psychology of the buyer and how to tell what your "hot buttons" are. They listen to things in your conversation that you may say to one another as well as to the salesman. They are trained to tell their desk managers everything that you say and then the desk manager is trained to tell the salesman exactly what and how to answer you. A seasoned salesman does not need as much advice from his desk and may negotiate a little more with you directly without going back and forth.
The process of negotiation begins the moment that you walk into the front door or step foot out of your car and begin to look at vehicles. Different stores display inventory in different ways. This is done for crowd control or more commonly known as "up control". Control is the first step in negotiating with a customer. Ever who asks the questions controls the situation. Let me give you an example: A salesman walks up to you and says "Welcome to ABC motors, my name is Joe, and what is yours?" The salesman has just asked the first question- you answer "My name is George." He then asks you what you are looking for today, or; the famous "Can I help You?" As you can see, step after step, question after question, he leads you down a path that he is trained to do.
Many times a well trained salesperson will not answer your questions directly. In some cases, they only respond to questions with other questions in order to avert the loss of control. An example of this could be something like you asking the salesman if he has this same car with an automatic rather than a stick shift. Two responses could come back to you. One would be yes or no, the other could very well be something along the lines of: 'don't you know how to drive a stick shift?" In the second response the salesman gained more information from you in order to close you. Closing means to overcome every objection and give your customer no way out other than where do I sign. The art of selling truly is a science of well scripted roll playing and rehearsal.
We have established that the negotiating process begins with a series of questions. These questions serve as two main elements of the sales process. First and foremost is to establish rapport and control. The more information that you are willing to share with you salesman in the first few minutes gives him a greater control of the sales process. He has gathered mental notes on our ability to purchase such as whether you have a trade in or not, if you have a down payment, how much can you afford, are you the only decision maker (is there a spouse?), how is your credit, or do you have a payoff on your trade in? These are one of many pieces of information that they collect immediately. Secondly, this information is used to begin a conversation with store management about who the salesman is with, what are they looking for, and what is their ability to purchase. Generally, a sales manager then directs the sales process from his seat in the "tower". A seat that generally overlooks the sales floor or the sales lot. He is kind of like a conductor of an orchestra, seeing all, and hearing all.
I cannot describe the entire sales process with you as this varies from dealer to dealer, however; the basic principals of the sale do not vary too much. Most dealerships get started after a demo or test drive. Usually a salesman gets a sheet of paper out that is called a four square. The four square is normally used to find the customer's "hot points". The four corners of the sheet have the following items addressed, not necessarily in this order. Number one is sales price, number two is trade value, number three is down payment, and number four is monthly payments. The idea here is to reduce three out of the four items and focus on YOUR hot button. Every person settles in on something different. The idea for the salesman is to get you to focus and commit to one or two of the hot buttons without even addressing the other two or three items. When you do settle in on one of the items on the four square, the process of closing you becomes much easier.
One thing to keep in mind is that all four items are usually negotiable and are usually submitted to you the first time in a manner as to maximize the profit that the dealer earns on the deal. Usually the MSRP is listed unless there is a sales price that is advertised (in may cases the vehicle is advertised, but; you are not aware). The trade value is usually first submitted to you as wholesale value. Most dealers request 25-33% down payment. Most monthly payments are inflated using maximum rate. What this all boils down to is that the price is usually always negotiable, the trade in is definitely negotiable, the down payment may be what you choose, and the monthly payment and interest rates are most certainly negotiable. If you do your homework prior to a dealership visit you can go into the negotiation process better armed. You still need to keep two things in mind through this process. The first item is that you are dealing with a sales TEAM that is usually highly skilled and money motivated. The more you pay the more they earn. The second item to remember is that you may have done your homework and think that you are getting a great deal and the dealer is still making a lot of money. The latter part of this statement goes back to the fact that it is essential for a dealer to make a "fair" profit in order to serve you better.
Once your negotiations are somewhat settled, you are then taken to the business or finance department to finalize your paperwork. Keep in mind that this too is another negotiating process. In fact, the finance manager is usually one of the top trained sales associates that definitely knows all the ins and outs of maximizing the dealerships profit. It is in the finance department that many dealers actually earn more than they earned by selling the car, boat, RV, or other large ticket item to you. We will break these profit centers down for you and enlighten you as to how the process usually works. Remember that finance people are more often than not a superior skilled negotiator that is still representing the dealership. It may seem that he or she has your best interests at heart, but; they are still profit centered.
The real problem with finance departments are that the average consumer has just put his or her guard down. They have just negotiated hard for what is assumed to be a good deal. They have taken this deal at full faced value and assume that all negotiations are done. The average consumer doesn't even have an understanding of finances or how the finance department functions. The average consumer nearly "lays down" for anything that the finance manager says. The interest rate is one of the largest profit centers in the finance department. For example, the dealership buys the interest rate from the bank the same way that he buys the car from the manufacturer. He may only have to pay 6% to the bank for a $25,000 loan. He can then charge you 8% for that same $25,000. The dealer is paid on the difference. If this is a five year loan that amount could very well be $2,000. So the dealer makes an additional $2,000 profit on the sale when the bank funds the loan. This is called a rate spread or "reserves". In mortgages, this is disclosed at time of closing on the HUD-1 statement as Yield Spread Premium. This may also be disclosed on the Good Faith Estimate or GFE. You can see why it becomes important to understand bank rates and financing.
Many finance managers use a menu to sell aftermarket products to you. This process is very similar to the four square process that I discussed in the beginning. There are usually items like gap insurance, extended service contracts, paint and fabric guard, as well as many other after market products available from this dealer. The menu again is usually stacked up to be presented to the consumer in a way that the dealer maximizes his profitability if you take the best plan available. The presentation is usually given in a manner in which the dealer wins no matter what options are chosen. With the additional items being pitched to you at closing, your mind becomes less entrenched on the rates and terms and your focus then turns to the after market products. Each aftermarket item can very well make the dealer up to 300-400% over what he pays for these items. Gap coverage for example may cost the dealer $195.00 and is sold to the consumer for $895.00. The $700.00 is pure profit to the dealer and is very rarely negotiated down during this process. The service contract may only cost a dealer $650.00 and is being sold for $2000.00. The difference in these items are pure profit to the dealer. You see, if you only paid $995.00 for the same contract, the dealer still earns $345.00 profit from you and you still have the same coverage that you would have had if you had paid the $2000.00. The same is true for the gap coverage. You are covered the same if you paid $395.00 or $895.00 if the dealers costs are only $195.00. The only difference is the amount of profit that you paid to the dealer. Another huge profit center is paint and fabric protector. In most cases the costs to apply the product are minimal (around $125.00 on average). In many cases the dealer charges you $1200-$1800 for this paint and fabric guard.
As you can see, these products sold in the finance department are huge profit centers and are negotiable. I also have to recommend the value of most all products sold in a finance department. It is in your best interest to get the best coverage possible at the best price possible. Always remember this: The dealer has to make a fair profit to stay in business. It just doesn't have to be all out of your pocket.
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Effect of Modern Finance on Small and Medium Enterprise - SME
There are views about the relevance of modern finance which is usually tailored or formulated with the view of large organisations in mind thereby ignoring small enterprises (McMahon et al, 1993). This neglect of financial management in SMEs is understood to be as a result of neglecting SMEs in the development of economic theory. However, the situation is changing due to globalisation. Thus there is the view that small enterprise financial management has not been developed with the small enterprise in mind. New empirical evidence raises the possibility that size may affect financial relationships in an important manner. These findings might themselves justify an expanded research emphasis on the effect of business size on financial policy. Sahlman (1983, 1990) refers to what he terms as 'primitive rules' in modern finance. In effect this attitude accounts for the inefficiency of small enterprises in financial management.
Ghanaian SMEs like other SMEs are missing out on modern finance theories. For example, CAPM is based on the following:
o The principle of risk aversion i.e. investors seeking higher returns and lower risks all things being equal.
o The principle of diversification i.e. investors do not place all their wealth into one investment portfolio, and
o The principle of risk-return trade-off i.e. the willingness to face a higher risk for a higher return. (Emery et al, 1991).
This can be related to the behaviour of the owner who is not risk-adverse .He is looking up to make a lot of profit by importing from other countries with unstable political situation.
These uses to CAPM to the SME are really unparalleled in the study. Most owner-managers in Ghana are risk-averse yet they seek higher returns from their investments.
Working capital policy is somewhat related to SMEs in terms of its operations. In relation to the reasons with which an owner-manager operates a business, there is no obligation to account for their actions. Thus the management of working capital is influenced by this style of running the small enterprise.
Working capital management thus seeks to meet two objectives-
i.to minimise the time between the initial input of materials and other materials into the operating process, and the eventual payment for goods and services by customers; and
ii.to finance those assets as efficiently as possible for an optimal return on capital employed.
Operations of SMEs in Ghana were found to relate to the working capital policy in their quest to be efficient and timely.
With all intents and purposes, debtors' control and management are difficult tasks. To effectively-manage debtors, the following issues must be carefully considered, well-planned and controlled:
Credit period- The credit period given to each customer must be considered in terms of the customer's credit rating; whether the costs of increased credit matches the profit to be made on the sales generated by the credit terms; and the general credit period being offered in the industry.
Credit standards must be set- For example customers must be taken through credit assessment ratings to weigh the risk they pose. Usually in giving credit to customers, the appropriate standard rule is to check the maximum period of credit granted; the maximum amount of credit; and the payment terms including any discounts for early payment and the interest charges on overdue accounts.
From my working experience in Ghana, one of the effective means was to take post-dated checks in addition from debtors. These must be spread across the duration to make the payment as agreed with the customer. Default, however, is inevitable in all circumstances.In spite of any shortfalls, the techniques used above can enhance a firm's ability to control working capital effectively. For most small business enterprises whose total investments are represented in greater proportion by current assets, the techniques discussed above prove to be as useful for their management as the importance of their financial management.
This is very significant here because it clearly shows that most SMEs could stay in business for a very long time to come if they could apply financial management techniques effectively.
There are many published research including those of Olsen et al. (1992); Higgins (1977 pp7); and Babcock (1970) who are strongly of the view that growth must be viewed in a strategic context of financial management. They emphasise on a concept, which has variously been referred to as sustainable or affordable or attainable growth. This sustainable growth is defined by Higgins (1977) as "the annual percentage of increases in sales that is consistent with the firm's established financial policies".
Agreeing with this definition in this context; suffice it to say that it makes sense to relate a firm's growth to its financial policies. By tailoring one's financial management policies to the annual percentage increase in sales(which might be controlled),there is the possibility of achieving the sustainable growth and the ability to finance its permanent current assets as well as the non-current assets due to the rapid expansion in growth.
One can, however, argue that the rate of growth in sales can be influenced. For an enterprise which is intended to realise its full growth potential in the long-run in spite of the problems in securing an external equity funding, the only viable growth strategy is the profitability of the firm's operating activities and the careful profit distribution policy. It could also be argued that those SMEs which "do not want to grow" can also apply the financial management techniques effectively and survive in the market.
Financial Management of small enterprises is thought to be different from that of large enterprises. In a paper entitled 'Small business uniqueness and the theory of financial management' Ang (1991), and 'On the theory of finance for privately held firms' Ang (1992), Ang considers businesses to be small if they have certain features and small business to share common circumstances, respectively. He later on concluded, "Small businesses do not share the same financial management problems with large businesses...the differences could be traced to several characteristics unique to small businesses. This uniqueness in turn creates a whole new set of financial management issues.... There are 'enough differences between large and small firms' financial management practices and theory that justify the research effort to study the latter".
Another significant difference between SME financial management and modern theories on financial management is Capital Assets Pricing Model theory (CAPM). It is a finance model which captures the relationship between return and risk; specifying how it affects the valuation of financial and physical assets.
CAPM is simple, market-based and an objective means of estimating required rates of return for investments which reflect the collective preferences of all investors in the capital market. To a small enterprise, however, there is difficulty in estimating systemic risk-the risk that the whole system will fail, for example the stock exchange- because small business enterprises are not publicly traded or the investment is in a physical asset with no well-informed market due to the fact that the parameter is more effective if the investment is publicly traded. (McMahon et al.1993). The question then arises. What has this got to do with a small business enterprise then?
In real-life situation when there is a degree of uncertainty, the financial manager(just as the owner-manager) decides on the course of action to determine the level of finance required and for that matter the long-term financial strategy.
Because Owner-Managers have many duties to carry out,it was found out in the study that they frequently do not have enough time to devote to long-term planning of the company. Instead, most of their time is spent on day-to-day operational activities and in solving the current day's crisis.Also due to cyclical or seasonal nature of many small businesses the amount of working capital required can vary enormously. The greater the seasonality the less permanent capital a firm has in relation to its total requirements in peak periods. SMEs are for that matter vulnerable to working capital management fiasco which can degenerate into poor financial management.s