Are You Seasonally Adjusted?: Keeping on Top of Annual Cash Flow Fluctuations

As we enter summer each year, businesses with a seasonal sales cycle can change significantly. If you are lucky, this is your busy season with expanded revenue and, hopefully, expanded profits and cash flow. If you run a business that has diminished summer sales, you are in for the belt-tightening process of reduced revenues and cash flow.

Either way, it's critically important to understand patterns of cash flow--and how to best prepare for the seasonality of sales that most businesses experience during the course of a year. Our goal as owners is to determine the pattern of cash flow in our businesses and plan for adequate cash to cover expenses and repay debt. It is also important to clearly understand the difference between "seasonal" cash requirements and your long-term growth capital needs.

1) Planning for cash flow. Planning is critical. Start by looking at what happened in the past in your business, then assess what is going on now. Next, begin to think about what you would like your business to look like over the next 12 months. A lot of things can affect this plan: new competition, summer road construction, for example. However, the more we plan, the more our thinking is refined, and the closer we can get to our cash flow goals. The critical tool to help in this process is your cash budget (which is very different from the other two key financial tools used by every business owner: your income statement and your balance sheet).

2) Accrual accounting. Your income statement is typically based on accrual accounting. Income is recognized when you earn it, not when the money is collected; and expenses are recognized when they are incurred, not when the bills are paid. By matching the income earned against the expense generated to earn it, you always get an accurate picture of the profitability of your business. The critical weakness of this accounting system, however, is that you do not get an accurate picture of the timing of inflows and outflows of cash. Cash flow is the weak link of the accrual method of accounting.

3) Cash accounting. In cash accounting you recognize your income when you get the money, and you recognize your expense when you write the checks to pay your bills. The strength of this process is that you always know your cash flow, but you have no idea if you're actually making any profit.

4) Cash budgeting made simple. To truly understand what is happening inside your business, you need a cash budget. To build a cash budget that truly delivers "management intelligence," you need three distinct components.

1. First, across the top, prepare a Profit Plan (which is nothing more than a simplified income statement) month by month for 12 months. Project your sales, cost of goods sold, gross margin, G&A expenses, and net profit, calculated for each month, usually for January through December and totaled for the year.
2. Next, beneath that prepare your cash budget (which is no more complicated than your company checkbook). At the top, begin with the cash from the previous month, add in all the receivables and other income you expect to collect. Then subtract everything you intend to pay (bills, payroll, taxes and any other expenses due each month) and you will wind up with your ending cash position. Amazingly enough, this could very likely be negative, which leads us to the last component of the three-part cash budget: your loans.
3. To bring your business back to solvency for the month, you must track the short-term borrowing you need from your line of credit with the bank. Whatever is left over in cash is what you will use to begin the cash budget for the next month. If you are in a highly seasonal business, it is very likely that this short-term borrowing could be extensive. The good news is that with careful planning you should be able to track the repayment and, hopefully, have the entire line of credit paid off by the end of the 12-month period.

(This entire process is outlined in our Profit Mastery Module Four: Cash Flow, available through our online Profit Mastery University.)

Know before you go. The typical business owner only guesses as to the amount of borrowing they will need to cover the cash shortfall during the course of the year. If you think you'll need $50,000 to keep your business afloat during its seasonal sales cycle, and it turns out that you actually need $220,000, this can lead to "polite adversity" with your friendly banker, and to great stress on you. A cash budget enables you to "know before you go" and plan for the seasonal cash needs of your business.

Steve LeFever is the founder and chair of Business Resource Services (BRS), a Seattle-based consulting firm that provides financial management education, network benchmarking, performance group facilitation, and bookkeeping services for closely held businesses under its Profit Mastery brand. Rod Bristol is senior vice president at Profit Mastery. Learn more at www.profitmastery.net, 800-488-3520 x14 or write to lefever@brs-seattle.com.