Increasing interest rates impact dealerships in multiple ways — none of which are good.
We have seen an unprecedented increase in interest rates over the past few years.
It wasn’t so long ago that you were able to borrow money for, what felt like, nothing. When rates were low, the economy was booming — dealers were growing, acquiring and reinvesting in new technology. The industry was thriving. The world was our oyster. Everything dealers touched turned to gold.
Things have changed. Rates have increased at a pace that we’ve never seen before and that has significantly slowed the economy. Customer buying patterns have changed and the state of the nation today is weak. For the first time in a long time, dealers are concerned for the future.
Increasing interest rates can have several significant impacts on dealers in Canada. They impact their ability to borrow, manage cash flows and profit margins. They cool the overall automotive economy and cause delays in investment decisions. Credit availability is tightened and the whole economy slows.
Let’s look at some of these impacts more closely.
Higher Borrowing Costs
Auto dealerships rely on loans from a variety of financial institutions to run their businesses. They use them for expansion, equipment purchases, and daily working capital requirements.
As interest rates rise, the cost of borrowing increases, which makes financing more expensive and reduces the amount of capital available in the financial system.
Without availability of funds, dealers are forced to pivot, change their growth plans and work to internally decrease the amount of spending through cutting expenses.
Lack of cash will always translate to lack of spending, and this has a direct impact on a dealer’s ability to survive in the long run.
Reduced Cash Flow
Most dealers borrow based on a floating rate system. Their monthly payments depend on the borrowing rate of the day; therefore, higher interest rates have a direct strain on cash flow.
This is particularly challenging for dealers whose businesses run with tight profit margins and whose customers’ buying decisions heavily depend on credit. Lack of cash will always translate to lack of spending, and this has a direct impact on a dealer’s ability to survive in the long run.
Investment Delays
Dealers generally invest big in their businesses. Big buildings, big inventory, big headcount. But what if the cost of betting big outweighs the return you will receive?
If this is the case, small businesses might delay or scale back investment plans due to higher costs of financing. This can impact their growth potential and competitive positioning in the market.
If enough dealers in your geographic area are doing this, the entire state of the automotive space can be impacted. Less investments in dealerships translate to less employment which leads to less customer spending altogether. And the cycle goes on and on.
Pressure on Profit Margins
Increased borrowing costs can erode profit margins. This happens in a few different ways. First, if dealers are unable to transfer the higher financing costs to customers, they will have to absorb them internally.
Second, if customers can’t afford to pay full price for vehicles, they will be demanding reduced selling prices to complete buying transactions. Both these examples will have a direct impact on a business’s profitability and could, in the long term, cause businesses to revisit their ability to continue as a going concern.
Credit Availability
As a result of the above, financial institutions will tighten their credit standards and make it more difficult for small businesses to secure loans.
This can limit dealers’ ability to grow or manage financial challenges and inevitably cause economic uncertainty. Consumer and business behaviour will change. Small businesses may struggle with planning and forecasting in an uncertain economic environment, forcing them to change growth plans and aggressively cut expenses to remain afloat.
During times of increasing interest rates, it is more important than ever to practice careful financial management and strategic planning.
Watch your spending and rethink your need to grow. Walk slowly and don’t make decisions without proper data. Ensure you act in a fiscally responsible way during these difficult times.
Good luck.
