Seasonality and Cash Flow
One of the most frequent sources of cash flow problems for a small business is seasonality. Some industries, such as retail, may experience the majority of their sales during the Christmas season. Some industries like agriculture are affected by growing seasons. Some locations, like Florida, are subject to tourist seasons. As bankers, it is essential that we understand the nature of our clients' businesses.
The best indicator of seasonality is historical performance. A month-by-month income statement over a couple years can enlighten the lender to their client's seasonality. Cash flow management is particularly important for seasonal businesses, which are more likely than others to face irregular cash flow patterns.
Business owners resolve their seasonal cash flow problems through a number of methods. Some of the most common are:
Putting aside funds during the strong season,
Using personal resources,
Reducing overhead during the weak season,
Increase collection actions,
Slow payments to trade creditors,
Borrow additional funds during the weak season, and
Scheduling lower payments during the weak season.
As a Floridian, I will share one example from my own past as a lender. I had inherited a restaurant client when I was hired by a new bank that suffered from weak cash flow during its off-season (summer). Their previous lender at the bank had provided them with a term loan with level payment throughout the year. They made their payments timely during the fall, winter and spring, but during the summer they had a large number of overdrafts. They were able to cover their overdrafts with the previous night's receipts, but incurred huge fees during the summer months which eroded the small amount of working capital they had. In the first year there was little I could do as the bank would not approve a summer loan to this "challenged" customer. During their second year, we restructured their debt with interest only payments in the summer months and normal principal and interest payments during the rest of the year. Over the following year, they still had some overdrafts during the summer months, but they were cut significantly. By the third year, the restaurant was not only profitable but kept positive balances in their accounts going forward. My conclusion was that the original lender did not understand the business and structured their debt in such a way that they were doomed from the start. A seasonal payment adjustment helped turn a classified credit into a thriving business.
It is essential that a company's payment stream match its income stream, particularly with a seasonal business. Structure skip payments or interest only payments during traditionally weak months. Newer businesses may not have enough cash reserves built up during the weak season.
Certain seasonal businesses may have large fluctuations in their current ratio and cash cycle during a year. For these companies it is essential to understand seasonal (temporary) needs from long term needs. This will help the lender structure the appropriate loan program.