Many businesses experience seasonality to one extent or another. Not only is there sales seasonality, but revenue and expenses both have seasonality, sometimes in synch but sometimes staggered. There are accounting rules (called matching principles) that try to match the expenses to the related revenue but these rules often mask the impact on cash in the bank and can fool the unsuspecting business owner into believing that they are in a different position than they actually are.
To eliminate the accounting rules let’s only look at cash flow. After all isn’t cash flow the truest measure of business health?
We’ll take a simple business that has $1M in sales per year, its fixed costs are 25% and the variable costs are 55%. Using this simple approach we have a business with an enviable profit of 20% which generates $200k in excess cash per year.
Every month is the same with predictable cash inflows and outflows perfectly synced. Cash grows at a predictable pace… as it was imagined.
As said before most businesses have some sort of seasonality with business fluctuating based on some driver. It’s easy to think of the obvious weather seasonality businesses such as farms and ski resorts, but sometimes the drivers of seasonality are less obvious such as the tax year for businesses like Opticians that get a surge in business as people use up their flexible spending accounts or the end of the Football season which drives pizza delivery sales in January.
Using our Million Dollar business let’s now add some simple warm weather seasonality while leaving everything else unchanged.
It still has the same year end cash balance but because of fixed expenses it experiences negative cash flow for the 1st quarter of the year.
What do you think it would look like if the inflow and outflow were staggered because of having to pay seasonal laborers to plant the crops and work the farm well before harvests start to come in?
Another fact of doing business is that cash does not always flow in when the sale is made. Accounts receivable can reflect the last 30 days of sales or more. It seems that you never get paid as quickly as you pay your suppliers and employees. These two points can further complicate the cash flow of our Million Dollar business.
By having 30 days of sales outstanding at any given time, now our cash shortfall is nearly $200,000 and the year end balance is still the same. The good news is that the business has finished its first year with $200,000 more cash than what it started with. Year two should look different
Relatively simple cash flow forecasts can help identify the impact of seasonality on your business and keep you from getting blindsided. We have been working with small and medium sized business owners to identify and model the drivers of their business so that they can better plan for cash surpluses and needs. Please contact us if we can be of any assistance.
The Shared Finance Center provides outsourced accounting, bookkeeping and fractional CFO support to small business owners and in doing so we heavily focus on maximizing cash flow. We are headquartered in Roswell, Georgia and work with clients across the United States. If you think that this post would be helpful to anyone you know, please pass it along. Also please follow our blog for regular tips to grow your business.