The chances are that at some point, you’ve driven past an auto dealership and wondered how they can possibly afford to keep all those vehicles in their inventory.
Since cars and trucks are major purchases that require a high level of financial investment, maintaining a sizable inventory involves a substantial outlay of funds. What you might not realize is that a floorplan was used to finance most of the vehicles you see on that lot.
This article will break down what you need to know about floorplan financing, how it works and what it means to the auto retail industry at large.
What Is Floorplan Financing?
Floorplan financing is simply a way in which auto dealers use lenders’ money to finance their inventory. In this arrangement, the dealer comes up with a big selection of vehicles that customers can drive straight off the lot if they want to. Until these vehicles are sold to the buyers, the lender simply retains their titles.
The dealer receives payment, including profit, and remits the balance to the lender. The lender then releases the vehicle’s title to the new buyer. Without floorplan financing, most dealerships wouldn’t be able to keep the enormous volume of inventory they need to keep their showrooms ready for same-day sales.
If dealers were unable to maintain a large selection of vehicles with a variety of styles, features and colors, auto buyers would need to order the vehicles and unique features they wanted from a catalog. Then, they would have to wait for these particular vehicles to be shipped to the dealer — a process that usually takes about a month or even longer. Therefore, such an arrangement is inconvenient from a customer’s point of view.
Additionally, it is much easier for the dealer to sell vehicles that are already in stock and ready to be driven. This grants customers enough time to fall in love with the vehicle. It’s important to note that maintaining such a big inventory also allows the dealer to make even more sales and earn more profits.
Therefore, for most dealers, floorplan financing is a great way to simplify inventory acquisition and reduce administrative costs. Simultaneously, customers get to have a large selection of vehicles to choose from.
How Does Floorplan Financing Work?
To put it in the simplest terms possible, floorplan financing works like a credit card created solely for purchasing vehicle inventory for dealerships. Much like a credit card, floorplan financing extends a line of credit to an auto dealer. With this line of credit, the dealer can then buy vehicles from auctions, trade-ins, fleets, private sellers, and other inventory sources.
This means that auto dealers don’t have to spend their own cash to finance inventory. However, if the auto dealer purchases a vehicle on a floorplan and doesn’t sell it within the specified amount of time on the contract, they’re charged a small fee. On the other hand, if the auto dealer sells their inventory, they can pay back the original loan.
When it comes to a floorplan, the initial investment needed to purchase a given unit is usually a fraction of the vehicle’s actual market price. Once the vehicle is sold to a customer, the auto dealer can earn profits, pay back the loan with the interests and fees, and have the flexibility to keep the money working for the dealership.
How Does Floorplan Financing Differ From Other Types of Loans?
When it comes to most commercial loans, the collateral involved is fixed. Floorplan financing changes this dynamic to give borrowers much-needed control over the collateral involved. Generally, floorplans are based on an aggregate budget, and they usually run for a one-year term.
For instance, in one year, an auto dealer might borrow a total of $10 million in order to purchase about 400 new vehicles. When an auto dealer who has a floorplan financing agreement needs to expand their current inventory, all they need to do is give the lender a list of the vehicles they want to purchase.
The lender then notes down these vehicles and their VINs and directly sends the manufacturer the amount they’ve agreed upon. However, given the volatile nature of this business and the fact that most auto dealerships operate with large inventories, auto dealers are usually vulnerable to inventory turnover as well as floorplan rates.
It’s important to note that even the slightest increase in the interest rate could easily translate to a significant increase in the auto dealership’s expenses. The profit margins associated with selling vehicles are usually thin. As a result, it’s crucial for auto dealers to borrow loans at competitive rates and stock their lots with the proper amount of vehicles.
Some lenders are unrelenting, especially when it comes to physically checking on an auto dealer’s inventory to ensure that their loan is covered according to the contract. If the inventory is moving more slowly than the lender likes, they might demand immediate payment from the auto dealer in order to cover the cost of potential depreciation of the collateral as well as the interest agreed upon.
