Monday, January 18, 2010

The Financial Swings of a Seasonal Business

Most businesses have at least some seasonality to them.  Perhaps the first quarter of every calendar year is always slow, or your business comes to a stand-still every November through December.  Here is an example of a business that slows dramatically ever summer:

2009 rev by month

Notice the valley from June to August between the peaks of April and October.  The same thing happens every year in this business - it is fairly predictable.  Even though it is predictable, this seasonality can still create financial stress every year.  Let me be even more clear - this seasonality causes gyrations in cash flow that are difficult to stomach.  Let me explain this phenomenon, then I will share a few steps every entrepreneur can take to reduce such financial stress.

CASH FLOW AND SEASONALITY
Let's start by talking about July, the lowest level of revenue all year.  The company shows a significant net loss every July because its low revenues and gross profit fall way short of covering the overhead and fixed costs of the business.  Yet, counter-intuitively, this is usually when the balance of cash in the bank account is the highest.  Why?  Because in July the company is collecting all of the April and May receivables but paying out very small amounts of variable costs (because the revenue volume is so low in July).  Although this may not sound all that stressful, it is when we talk about August through the rest of the year...

You see, as the volume of the business goes back up, there are very few receivables to collect from the summer months but variable expenses sky-rocket.  This is a huge cash drain on the business, and July is stressful because the entrepreneur is wondering if they will have enough cash to handle August through the end of the year.  Ultimately, this expansion in the working capital cycle returns to more efficient levels and the cash inflows catch up with the outflows by the end of the year.  The business returns to more steady cash flows until the next summer.  Please know that when I say stress, I am referring to the worries and concerns about making payroll, servicing debt, and meeting any other financial obligations that we worry about when our cash flow is not steady.

WAYS TO REMOVE THE FINANCIAL STRESS
1. Have a Budget and Review it Every Month - At the beginning of every year we implement a well-thought-out and planned budget for the entire year.  This takes into account the seasonality of the revenues and costs as well as projects the total overhead and fixed costs of the business.  This also projects the balance sheet and statement of cash flows so we can understand how all of this will impact our cash.  We review our budget after every month to make sure we are on track.  We also usually implement a "break-even" budget so we can ensure that if we are under-performing on our plan for the year we can still see that we will not lose money when the year is over.  This is especially useful to know when the slow times come - even though the business is not profitable during this time we can see whether or not we are still on track to make a profit by the end of the year when revenues come back up.

2.     Short-term Cash Flow Projections -We always keep at least 90 days of cash flow projected based on our current receivables, payroll, and other items as well as our revenue projections for that period.  This is updated weekly and reviewed by the management team.  It is amazing how few entrepreneurs fail to implement this simple yet often overlooked "stress-reduction tool."

3.     Plan Financing for Cash Shortfalls -With the business mentioned above, it is a well known fact at the beginning of every year that we will not have enough internally-generated cash to handle the upturn after the summer.  So, we determine how much cash flow we will need and make sure to have a line of credit in place to cover the shortfall.  Even though credit is tough for entrepreneurs these days, there are plenty of banks willing to loan to this company.  The company has a proven track record, it understands its seasonality and can communicate to the bank exactly what will happen with its cash flow through the year, and it has an attractive asset (the receivables) and strong personal guarantor (the entrepreneur).  This company is very "bankable."

4.    Resist the Temptation to Diversify into Non-Core Competencies - Some might look at the chart above and think it would be best to try and increase revenue during the summer months to solve the cash flow challenges of the business.  While this is great in theory, it is typically impossible in practice without compromising the core competencies of the business and, ultimately, hurting more than helping the company.  As entrepreneurs, we need to embrace the seasonality of our business as well as our core competencies and not deviate from them.  Understanding, budgeting, and planning are usually more effective than diversification.

CONCLUSION
The keys are summed up in the last sentence - understanding, budgeting, and planning.  The more you do of those three the less your financial stress will be in your seasonal business.  Reducing this stress will free you up to grow your business or spend time doing other things you love.