September 12, 2022
Adam Hoeksema
In this guide I want to give you all of the financial information you will need to determine whether you should open a used car dealership, how to do it, and what financial results you might be able to expect from starting your own used car dealership. Here is what we are going to look at:
- Is the used car dealer industry a good industry?
- How much will it cost to start a used car dealership?
- How much revenue can a used car dealership make?
- How do used car dealerships finance vehicle inventory?
- What are the typical gross profit margins for a used car dealer?
- Should you add a service department to your dealership?
- How much revenue can a car dealership service department generate?
- What are the typical expenses associated with selling a used car?
- What are the fixed expenses for a car dealership?
- How much can a used car dealership make in profit?
Along the way, we will also be referencing our Used Car Dealership Financial Projection Template which you can grab now and follow along.
With that, let’s dive in!
Is the Used Car Dealer Industry Worth Getting Into?
According to First Research there are approximately 25,000 used car dealers in the United States generating approximately $100 billion in annual revenue. Surprisingly there is a huge disparity among various sources for the number of used car dealers in the US. IBISWorld estimates that there are over 140,000 used car dealers in the US. This wide disparity makes me think that there are probably a lot of used car dealers that pop up and close every year. It also makes you wonder how to define a used car dealer.
Is a car owner with a few vehicles for sale in their yard a used car dealer?
Maybe, but for the sake of this guide I am going to focus on used car dealers that hit a scale that could at least support 1 full time employee. If there are truly 140,000 used car dealers in the US, that would mean that the average dealer sells less than 2 vehicles per month. Maybe there are a large number of used car dealers operating a small dealership as a side hustle. Again for this article we will assume you want to operate a full scale used car dealership.
According to IBIS World the used car dealer industry has grown 2.4% per year between 2017 and 2022 with a clear COVID related dip in 2020 as seen in their graph below:
Growth for the industry seems to be back on track which makes it an interesting industry to jump into.
What are the Startup Costs to Open a Used Car Dealer?
So if you have decided to make the jump into the used car industry, you will need to know what to expect in terms of startup costs. Typical startup costs for a used car dealership include:
- License and permits
- Advertising and promotion
- Insurance
- Utilities
- Dealership facility - lease, purchase or new construction costs
- Equipment and Furniture
- Initial inventory
The startup costs for a used car dealership can range from $100,000 to $950,000 or more based on the following sources that we found:
- ProfitableVenture estimates used car dealer startup costs of $250,000 - $950,000.
- CPAPracticeAdvisor estimates startup costs of $100,000 - $200,000.
Although nearly a $1 million startup cost is a hefty price tag, according to a study by the National Automobile Dealers Association the cost to open a new car dealership is $11 million on average.
With such high startup costs, let’s hope you can generate some significant revenue to provide a return on your investment. We can dive into revenue projections for a used car dealership next.
How much Revenue do Used Car Dealers Typically Generate?
According to First Research there are approximately 25,000 used car dealerships in the US generating around $100 billion in sales annual. Using a simple average we can estimate that the typical used car dealership in the US generates $4 million in annual revenue. In order to generate $4 million in annual sales a used car dealer is going to need to sell roughly 120 vehicles per year, or 10 per month. We came to this conclusion based on the average sales price of a used car at $33,000.
$4 million divided by $33,000 = roughly 120 vehicles sold.
When you are forecasting revenue for your used car dealership, we always recommend a bottoms up approach. You don’t just want to assume blindly that you will sell 120 vehicles per year, you need to build out some assumptions to show how you get there. In our car dealership financial model spreadsheet we build out assumptions for:
- # of walk in visitors to the lot
- % close rate of visitor to car buyer
- Breakdown of typical vehicle purchase per buyer
You can see how these assumptions help us build to total projected monthly revenue below:
In order to sell cars, we need cars on the lot. Let’s dive into more detail on how financing used car inventory works.
How to Finance Inventory for a Used Car Dealership?
So if we assume that the average dealer sells roughly 10 vehicles per month we know that you will need to hold some inventory of vehicles on your lot.
How much inventory should a used car dealer hold on the lot? According to Max Digital, the average used car dealer should hold 30 days worth of inventory on the lot.
For our example, if you are going to sell 10 vehicles per month, that means you need to have 10 vehicles on the lot at all times. If we assume that your price for the average vehicle on your lot is $25,000, you need to come up with $250,000 in cash for your inventory.
Assuming you don’t have a quarter million in cash laying around, how do used car dealers come up with the cash to buy vehicle inventory?
Fortunately there are industry specific lenders that provide what is called “Floorplan financing.” As a used car dealer you will want to find a lending partner to finance your inventory. You might be able to get a line of credit from your local bank, but there are also a number of specialty lenders or loan products like Ally’s wholesale financing that can help.
As the dealer you are essentially taking out a line of credit to purchase your inventory and then as those vehicles are sold, you will pay down the line of credit. You can expect, just like any other business loan, you will need a solid credit score and the lender may also want you to have some amount of down payment. If you are buying $250,000 worth of used cars, don’t be surprised if your floorplan financing company wants you to come up with 10% or more as a down payment or equity.
What are the Typical Gross Profit Margins for a Used Car Dealership?
As a car buyer I always wonder how much gross profit margin the dealer is actually making from me. Always worried that I might get taken advantage of, and I suppose in one off cases a buyer could overpay for a car, but on the average, gross profit margins for a used car dealer range between 11 and 13.5% according to Mercer Capital.
So when we think about a small used car dealership generating $4 million in annual revenue, we can expect gross profit of just $540,000 at the high end.
Why Should you Consider Adding a Service Department to Your Car Dealership?
Given that we just determined that the average used car dealer might only generate $500,000 in annual gross profit on vehicle sales, it makes sense to look for additional sources of revenue. Adding a service department can diversify and stabilize your sales and profits. Although vehicle sales will likely generate a majority of your revenue, the service department can actually generate a substantial percentage of gross profit. According to NADA, the service department represented 49.6% of dealership gross profit for those dealers with a service department.
How much Revenue do Service Departments Generate for Car Dealerships?
The reason that a service department can generate substantial revenue and gross profit over time is because each time you sell a vehicle to a customer, you have the opportunity to convert them into service department customers as well. The vehicle sale is a one time sale, while the service department can substantially increase the lifetime value of your customers.
The Balance estimates that the average cost of vehicle repairs and maintenance per year is roughly $1,000. If you sell 10 vehicles per month and can convert 50% of those customers to become service department customers, you can generate an additional $60,000 in annual revenue each year which will build on itself over time as you add more and more customers to your service department.
What are the Variable Costs for a Used Car Dealer?
There are a number of variable costs for a used car dealer that will increase or decrease based on vehicle sales volume. For example, for each vehicle that you sell you can expect to fill it with gas, change the oil, and clean the car at a bare minimum. Some car dealers will actually build a car wash on site that they can use internally, along with selling car wash services to the public.
Note: If you are interested in learning more about the financials behind the car wash business, check out our Car Wash Financial Model Template.
Some additional variable expenses you will need to account for each time you sell a car will include:
- Payment processing fees
- Sales commissions
- Vehicle title work
Your variable costs for the service department will include parts and labor expenses along with shop supplies that are used in the service process.
What are the Fixed Operating Expenses for a Car Dealership?
Some of the fixed operating expenses a used car dealer can expect to have include:
- Advertising
- Bookkeeping
- Marketing costs
- Rent
- Utilities
- Supplies
- Software and subscriptions
- Insurance
- Salaries
Depending on your particular business model you might expect additional operating expenses as well. You will need to do your own research for your specific model and location.
How much Profit can a Used Car Dealer make?
Ok we are finally to the big question. Can you make a profit operating a used car dealership? Of course the answer is yes, but providing a specific number to expect is difficult. It of course depends on your sales volume, gross profit, and operating expenses. We recommend that you fill out our Car dealership financial projection template to come up with as realistic as possible financial projections for your specific business plan and location. I walk you through the template in the video below to help you project your used car dealers profit potential:
Although I think you should really try to nail down the specifics for your situation, we can use some rough industry averages to help estimate the profit potential of a used car dealership.
If we assume a dealership with the following details:
- $4 million in vehicle sales annually
- 12% gross profit margin on vehicle sales
- = $480,000 in gross profit
- $500,000 in service department sales
- 40% gross profit margins on auto repair and maintenance services
- = $200,000 in gross profit
- Total gross profit of $680,000
Then we can estimate some expenses like:
- $200,000 on salaried staff positions
- $100,000 on rent and utilities
- $80,000 on marketing and advertising
- $50,000 on miscellaneous expenses
That leaves us with a potential profit for a used car dealership of $250,000.
At the end of the day, your potential profit will be dependent on your specific model, location, competition, the current economy and your operational excellence among other factors, but given the fact that the industry sustains tens of thousands of used car dealers, we are certain there is opportunity for profit for the right entrepreneur in the right market.
If you have any questions or need some help pulling together some financial projections for the bank, please feel free to contact us today.
