Floor Plan Financing Explained: FAQs and Words of Advice

Floorplan financing
By Marketing team
February 07, 2019Articles

Have you ever driven past a large auto dealer and wondered how they can possibly afford to keep all that expensive inventory on their lot?

Vehicles are big-ticket items, after all, and with hundreds of cars at any given dealership, just maintaining a manageable inventory represents a substantial outlay of funds.

The answer is simple: floor plan financing.

 

What is floor plan financing?

Floor plan financing allows auto dealers to use a lender's money to finance their inventory. The dealer emerges from the arrangement with a large selection of vehicles customers can drive straight off the lot should they please. Up until the time those cars are sold to the end-user, the lender retains their titles.

Without such an arrangement, most dealerships wouldn't be able to keep anywhere near the ideal volume of merchandise they need in their showrooms, ready for an impulse buy or immediate, same-day sale. Customers would instead need to order their vehicles and any special features they desire from a catalogue. They would then have to wait until it was shipped to the dealer, a process that typically takes a month or longer. 

Not only is such an arrangement untenable from a simple customer service standpoint, but for a dealer it's far easier to sell merchandise when it's in stock and ready to be taken for a test drive, granting customers ample time with a vehicle to fall in love with it. Plus, by maintaining a larger inventory of products, simple mathematics dictates that dealers are apt to enjoy greater sales.

From a dealer's perspective, floor plan financing is a practical way to streamline inventory acquisition and reduce administrative costs. At the same time, consumers benefit from having a larger selection of available vehicles to choose from.

 

How does floor plan financing differ from other types of loans?

With most commercial loans the collateral involved typically remains static. Floor plan financing changes this dynamic to a certain degree, giving borrowers more control over their collateral.

Floor plan loans are typically made with a one-year term and based on an aggregate budget. For example, over the course of a year a dealer might borrow a total $5 million to purchase 200 new cars. When a dealer who has a floor planning arrangement wants to expand their inventory, the dealer first informs their lender of the vehicle they wish to purchase. The lender then notes the item and it’s VIN, and directly sends the seller (typically the manufacturer) the agreed upon sum of money.

Auto dealerships have large inventories, and given the volatile nature of the business, they become very vulnerable to both floor plan rates and inventory turnover. A .05 increase in their interest rate could easily represent – a substantial increase in expense to an auto dealership. Profit margins are notoriously thin with the sale of new vehicles, and as such the ability to borrow at a competitive rate and stock the proper amount of inventory is imperative.

Furthermore, lenders can be unrelenting when it comes to physically checking a dealer’s inventory to make sure their loan remains adequately covered. Should inventory be moving slower than the lender is comfortable with, they may demand immediate payment to cover interest and the potential depreciation of their collateral.

While much depends on the health of the lender/borrower relationship, this can become a challenge for the dealership: if inventory isn't moving off their lot as quickly as the lender might like, chances are it's because business is slow in general, hence the worst time to be hit with new payments.

 

Key factors to consider

The following are a few key factors for dealerships to consider when shopping for floor plan financing:

  • Be responsible

Don't over-extend your inventory. Just because you have a $2 million line of credit doesn't mean your business can afford it. This is Rule #1 when it comes to floor plan financing. If you buy more inventory than you can sell, you may find you won't be able to make your payments.

Being late or skipping even one payment will immediately raise alarm with your lender about the stability of your business, and the extra scrutiny that likely results won't be anything you welcome. The takeaway? Buy inventory in proportion to your sales figures.

  • Maintain good communication with your lender

Keep your lender informed of any changes to your business or that affects your inventory -- even seemingly trite alterations such as temporarily moving certain items to a different location.

If you're experiencing difficulties and know in advance that you won't be able to pay your bill in time, tell them immediately. The more transparent you are with your lender, the more likely they'll go to bat for you in a time of need.

  • Cash flow

A healthy cash flow is crucial to any business, and one sizable benefit of floor plan lending is that it frees up cash for other expenses. However, all that accessible cash has the potential to leave you believing your wealthier than you truly are.

You need to be prudent with your cash flow and also make sure that your bills don't all mature at the same time, potentially leaving you unable to pay them in full.

  • Collateral audits

Make sure your lender is always able to verify your inventory without struggle. Your collateral will be physically verified based on the agreed terms, typically on a monthly basis. When your floor plan provider can’t easily verify your inventory, it promises to leave them feeling apprehensive about your account.

  • Turn times

Rule of thumb in the auto retail business is that vehicles should ideally be turned within 45 days, as profit margins decrease over time.

At a certain point, should a particular vehicle remain unsold, it can be preferable to cut your losses and take it to auction or sell it very cheaply. This will enable you to acquire fresh inventory that hopefully moves a little faster while not raising any disconcerting red flags with your lender.

  • Manage your account properly

It's to your benefit to make sure you fully comprehend what expectations your lender will be holding you to. Know when your payments are due and never skip one or submit it late.

 

The bottom line

When investigating floor plan loan options with commercial lenders, dealers should seek lenders who have a history working with auto dealerships and understand the business.

Look into the institutions history with floor plan lending and learn about its operational infrastructure for monthly audits, reporting and  the process they follow when paying manufacturers for your inventory.

Also, be open and honest about your business with your lender -- build a strong relationship based on trust. Should your business ever be in danger of insolvency or really need some extra help, your personal relationship with your lender could prove to be extremely valuable. Ideally, you want to be dealing with the same people five years down the road as you are today.

Our experts can help you build a financing program that fits your needs. Contact us to find out if floor plan financing is right for your business.