Are you an innovative entrepreneur with a summer seasonal business such as lawn care, outdoor adventure or guided tours? If so, how do you deal with the swings of your operational costs in the off-season? The type of business you have drives your operating cycle but may not coincide with your cash flow needs. Let’s look at ways you can effectively forecast operating costs and finance gaps in cash flow with a working capital loan.
The type of business you own determines your working capital needs, which vary widely due to seasonality. For example, a tour company in a historic city can bank a lot of money during the warmer months but will see business slow to a trickle when the weather turns. However, when the off-season hits, overhead costs to store the buses and keep qualified staff on retainer can eat into summer season profits. If you start a company that rents jet skis to summer tourists, you’ll need to pay for storage space and replace outdated equipment in the off-season. You may need to hire and train staff before revenue starts rolling in during warmer weather.
How can you plan for this in your own business? Recognizing seasonality in your planning process can give you an accurate picture of how much cash your fluctuating income demands.
Working Capital is current assets minus current liabilities. However, this simple formula doesn’t account for seasonality. To avoid additional costs and maintain healthy relationships with vendors, make sure your budget includes seasonality.
If your business is purely seasonal, then using a trailing 12-month average to forecast costs can be misleading, especially for off-season plan updates. Summer seasonal businesses (summer camps, construction and others) experience peaks and valleys in their revenue streams. This can be a problem if transactions are due in the downturn.
In this case, other methods of calculating your working capital are more effective. Consider the revenue expense ratio for the same period of the prior year. Another helpful tool is recalculating working capital as temporary working capital.
Calculate your TWC from your permanent working capital, as follows:
Temporary Working Capital equals Net Working Capital minus Permanent Working Capital
When you differentiate permanent and temporary working capital, you get a very accurate picture of how much cash you need to finance in the off-season. Preferably, you’ll use short-term financing sources as a temporary source until revenue starts flowing again.
Short-term working capital loans are more expensive to finance, but long-term financing cannot be acquired as quickly, and time is of the essence. Short-term financing also has more flexible lending terms. This means you get the cash you need and quickly repay it back. You pay the interest on the amount used for the short length of the loan, instead of over a period of years.