The CPA POV
Growing complexity boosts importance of due diligence in a buy sell
With dealership transactions being announced at a rapid pace, it may be tempting to assume that the risks surrounding these deals have diminished with increased market sophistication.
The opposite is true. Risk has not disappeared — it has grown in proportion to the size and complexity of today’s transactions. That makes doing through due diligence even more important.
As blue sky and real estate values increase, so does exposure. A mis-statement that may have once been immaterial in a smaller deal can now translate into significant valuation distortion.
At today’s values and earnings, even modest earnings overstatements can result in seven-figure pricing consequences. When coupled with working capital targets, large LIFO swings over the last couple of years, and image compliance requirements, small accounting inconsistencies can quickly compound into material financial risks.
Technology and the due diligence landscape
Transaction size is not the only change the industry has experienced over the past decade. Technology has fundamentally reshaped the due diligence landscape.
Not long ago, dealership due diligence largely revolved around reviewing financial statements, trial balances, and general ledger summaries. High-level trend analysis was sufficient to identify obvious concerns. Today, the approach of looking at a factory statement for a day is obsolete.
Modern cloud-based dealership management systems, electronic schedules, and sophisticated benchmarking tools provide unprecedented access to granular data. Accountants can now examine transaction-level details, analyze prepaids and other expenses parked on the balance sheet, and identify hardpacks or discounts recognized prematurely as earnings.
Contract-in-transit aging, F&I penetration metrics, departmental gross margins, and chargeback reserves can all be evaluated with far greater precision than simply a “swag.”
The promise and peril of AI
AI holds significant promise where due diligence is concerned. It can analyze 100 percent of entries rather than relying on sampling. It can identify unusual posting patterns, aging inconsistencies, duplicate transactions, and outliers far more quickly than manual review allows.
Over time, it may dramatically increase both the speed and depth of diligence. Yet with expanded accessibility and visibility comes the ultimate challenge of noise in the data.
In more than a decade of dealership diligence work, it is rare to encounter a store whose accounting is perfectly executed. Dealership environments are operationally dynamic and can be messy if there is lax training or adherence to policies.
Frequent reversals, reclassifications, manual journal entries, policy exceptions, and adjustments are commonplace in a store. Posting practices can vary significantly from store to store, and even from week to week if dealership personnel are rotating roles as they take vacations.
This creates a dense layer of transactional irregularities and inconsistencies that require professional interpretation. Experienced diligence professionals can recognize those patterns immediately as process fluctuations of an otherwise operational group, and not necessarily fraud or a possible earnings adjustment.
As a result, the abundance of data does not necessarily make diligence easier. It makes it more detailed and potentially more complex. Dealership diligence is a perfect example of AI not replacing people but making those who work with AI more valuable.
The future of dealership diligence will almost certainly be hybrid. Artificial intelligence will enhance the ability to identify risk areas quickly and comprehensively. Humans will remain essential for interpreting context, understanding operational realities, and assessing the economic substance behind the data.
Stuart McCallum is the founder and president of McCallum & Co., a full service dealership accounting and consulting firm serving dealers coast to coast.