ElI5 How do car manufacturers offer powertrain warranties without losing money?
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when a manufacturer sells a car, they set aside a pile of cash called the “warranty reserve”. This money is essentially a rainy-day fund that is meant to cover the warranty charges that car is likely to incur over its lifetime. That money set aside is collected from the buyer of the vehicle, but the company does NOT get to recognize this as revenue. It’s a sort of fiscal insurance policy self-funded by the manufacturer to cover future warranty claims.
On a quarterly basis, the company’s finance department will evaluate the rate of warranty expenditures by factoring in
1. the total population of other vehicles sold running on similar powertrains
2. a run-rate analysis of older vehicles in the fleet (sold cars) to gather information on general reliability as a way of projecting future failure rates using an assumption that no quality problems have crept into the manufacturing process
3. perform some analytical wizardry to project whether the warranty reserves that were set aside will over/under cover the expected long term costs
Once these analyses have been performed, the finance team will assert that warranty reserves can be trued-up / down. In an ideal situation, warranty reserves exceed anticipated costs and any overage in the reserve can be reclaimed and recognized as revenue (yay). Generally speaking, companies will try to minimize warranty reserves (safely) so that they can recognize that revenue immediately at sale.
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