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How to Determine Sales Margins on Used Cars

Purchasing a used vehicle can sometimes feel like you’re doing head-to-head battle with the salesman. You are sure there is a price threshold you’re not willing to exceed, while the sales associate is determined to get as much from you as possible. You can help your cause by learning how to determine sales margins on used cars.

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When you know sales margins and some of the other things that go into determining the cost of a used vehicle, you’re in a better position to negotiate. That’s because you’ll know the position from which the salesman is bargaining, what his weaknesses are, and where you can save the most amount of money. Not that you’re trying to steal from the used car dealer; you’re just trying to get the best price you can.

Definition of Sales Margin

Sales margin is often referred to as “gross margin” or simply “profit margin.” According to Investopedia, it is not the same thing as revenue or income. In other words, the company’s total income takes into account only the amount of money they received through sales during the year.

Sales margin is a different figure derived from taking the total income and subtracting the total amount of annual expenses.

It is a more accurate representation of the health of a given company. It also shows a company where improvements need to be made.

Let’s use a small company with $100,000 in sales as an example to illustrate sales margin. If that company’s total expenses for a year amounted to $90,000, that would mean a profit of $10,000. Sales margin is determined by comparing profit to total sales.

In this case it’s a simple mathematical formula most of us can do in our head. With $10,000 profit on sales of $100,000 the sales margin is 10%. This would be considered low in most industries; a good margin would be considered 15% or better.

Sales Margin in the Used Car Industry

In the used car sales industry, the margin is not so easy to figure out because expenses aren’t static. But consider the following types of things that the used car dealer must take into account: the cost of purchasing the used vehicle; the cost of paying the salesman’s commission; the cost of necessary repairs and upgrades; and overhead costs.

Perhaps the easiest of these factors to deal with is the sales commissions. When you first arrive at a used car dealership, simply ask whether or not the sales associates are paid based on commission, straight salary, or a combination of both.

If their income is a straight salary, you can figure that paying the associate doesn’t add a lot to the price of a vehicle.

For associates who get paid straight commission or commission and salary, their pay does significantly affect the price of a vehicle.

Being paid straight commission typically means a sales associate will be earning anywhere from 8% to 12% of the vehicle’s price.

When combined with a base salary, the commission is closer to 3% or 5%.

It’s a good idea to take a calculator with you so you can run these numbers. For example, if a car is listed at $10,000, you can figure the sales commission to be about $300-$500 for an associate who works on a combined commission and salary basis.

Overhead

By far, the biggest expense for the dealer is overhead. In most states a used car dealer is required to meet minimum standards of business operation in order to get and maintain a license. Let’s look at the state of Montana just as an example.

In Montana, used car dealers are required to establish a place of business with a physical structure that can be clearly seen from the road. They must have Internet access, telephone access, the proper signage, and the means on-site to provide the proper printed materials and records.

Furthermore, the dealership must maintain normal operational hours with verifiable employees on site during those times. The dealer must also maintain proper liability insurance and a minimum $50,000 surety bond. Finally, there is a renewal fee every year to maintain a license.

Adding Overhead into Sales Margin Calculations

Autoincome.com is a website dedicated to providing information to people interested in obtaining a used car dealer’s license.

They estimate that the average monthly overhead for America’s dealers is between $1,000 and $1,500.

Obviously, geographic location and state regulations can make that more or less in some areas.

Assuming $1,500 on the high side, casually ask your sales associate how many cars the dealership sells in a month. That number will be slightly higher than reality in most cases, but it’s still a good benchmark. If the sales associate tells you 100 cars, it means that $15 from each sale goes to pay the overhead.

Cost of Purchasing Used Cars

The last thing to consider in calculating sales margins is how much the dealer paid for the used car they are now trying to sell to you. The place to start is to look at standard used cars’ values using something like the Kelley Blue Book (KBB) or the National Automobile Dealers Association (NADA) guide.

For example, the NADA listing for a 2010 Ford Focus four-door sedan is about $11,800 retail. For an exceptional trade-in, a used dealer may spend about $9,500; the average trade-in value is about $8,700. If the car is in rough condition, a dealer may spend about $7,700.

Using our $10,000 car as an example, let’s assume the dealer paid closer to the $7,700 mark. Add in the $300 for sales commission and $15 for overhead, and you’ll see that the profit on a $10,000 sale is $1,985. That works out to a 20% sales margin for the dealer.

Negotiating Your Price

Keeping in mind that a 15% sales margin is generally acceptable for most industries, you have a little bit of wiggle room based on our example. If you could bargain the dealer down to $9,500, his profit would still be $1,485 for a sales margin of 15.6%.

To find out the sales margin as you reduce the price, simply figure out the profit at the current sticker price, then reduce both the profit and sales price by the same amount. Divide the new profit number by the new sales price and the resulting number will be the new sales margin.

To illustrate, we reduce the original profit of $1,985 and sales price of $10,000 by $500 apiece. Then we divide the new profit of $1,485 by the new sales price of $9,500 to get a sales margin of 15.6%.

Never Reveal Your Numbers

It’s best to never reveal your numbers to a salesman when you’re negotiating a price. That’s why it’s also a good idea never to buy a used car on your first visit. Instead, look a car over and find out what condition it’s in.

Get all the information you can in order to come up with an approximate guess about the car’s condition, the overhead a dealer might pay, the NADA value of a vehicle, and whether or not sales associates work on commission or salary.

Then go home and run the numbers to find out approximate sales margins.

At the same time, you can also determine how much negotiating power you have. If you’ve estimated the sales margin to already be near the 15% mark, you’re probably not going to have much room unless the dealer is desperate for sales. That’s something else you can gauge on your first visit.

When you go back for your second visit you should already have in mind a top price you’re willing to pay and a low price you’d like to pay. As you negotiate, you’re most likely going to agree on something in the middle.

Be Fair and Flexible

Although some people treat buying a used car like a sporting event, it’s not necessarily a wise idea. Don’t forget that used car salespeople and dealers have to make a profit in order to feed their families too. Don’t go into the deal with the idea that you’re going to pay just $100 more than it costs the dealer to do business.

That $100 may pay the salesman’s salary, but it won’t be enough to keep the dealer in business. And he likely has mouths to feed, just like you.

A good rule of thumb is to stick with the 15% sales margin whenever you can.

This is a fair deal for everyone involved. At 15% the dealer can afford to remain in business, the salesman will be able to earn a decent salary, and you’ll still be able to get a fairly good deal on a used car.

Of course, all of this is based on the assumption you know enough about used cars to make a wise decision. You should always have a used vehicle checked out by your own mechanic just to make sure you’re not buying a piece of junk. And you should also look around at a handful of different dealers to see what else is available.

If you’re shopping for used cars, you should shop just as aggressively for car insurance by entering your ZIP code into our FREE search tool!