The balance sheet shows all the assets and liabilities of a company. A business's assets and liabilities are constantly changing based on sales, financing and many other factors, so a balance sheet can only show a moment in time. However, this moment is useful for judging the state of the business, and company leaders and investors alike are interested in examining it. For dealerships, especially car dealerships, "contracts in transit" is an important item on the sheet that highlights the future expectations of the company.
Contracts in Transit
A contract in transit is essentially a contract that has been made with a dealership but has not been carried out yet to the extent that the business has actually been paid. For car dealers, this occurs when they sell a car to an individual who uses a car loan from a lender. The contract may be fully signed and agreed upon by all parties, but the lender may have not actually sent the funds yet or the lender has sent the funds but they have not arrived. In these cases, the money is a contract in transit.
When possible, dealers try to represent contracts in transit as a cash asset in the balance sheet. There are advantages to this approach. More cash in the business creates an improved cash flow statement and allows the company to compare its value to its debt more favorably when it comes to paying off short-term debts that it needs to have cash on hand for. However, because it is not actually cash in hand, counting contracts in transit as cash is not always the most accurate choice and depends on additional factors.
Contracts in transit are considered properly classified as cash if the dealer has a close relationship with the lender that is delivering the payment. If a dealership works with only one or two lenders that it has been working with for many years, risk is very low and the stability of the relationship is high. Thus, the business has grounds to consider the payment as good as made and can count the contracts in transit as cash.
Dealerships still can choose how to account for contracts in transit, and if they do not have a long-term or stable relationship with a lender, they should choose another option. The alternative is accounts receivable, the common collecting place for funds that are owed through credit but have not been paid. Contracts in transit are counted as accounts receivable on the balance sheet but moved to a cash account when the money actually arrives.