Working Capital Optimization Strategies During Seasons of High Demand

As a seasonal business, you require a substantial amount of cash on hand to navigate high and low demand. Here’s how to optimize that working capital.

If you have a seasonal business, now is a good time to start planning your working capital optimization strategies for the year, whether your business peaks in the summer or hits its stride during the winter holidays.

Working capital is the amount of operating liquidity you have available to fund business operations and invest in growth. Considered the lifeblood of any business, it’s measured by subtracting your current liabilities from your current assets. However, this formula doesn’t recognize the variations that come with seasonality.

Seasonal businesses typically require a high concentration of inventory expenditures leading up to peak season. This is followed by a steep spike in sales and delays before realizing cash payments. A seasonal business, therefore, requires a substantial amount of working capital to make necessary inventory purchases and fund operations as it waits for sales to clear accounts receivable.

If your business runs out of cash during this time, it could go bankrupt even if its net working capital is positive. This is all to say that seasonal businesses typically require a lot more working capital to make it through high-demand periods than nonseasonal businesses.

How to optimize working capital during seasons of high demand

1. Build an accurate cash flow forecast

One of the best ways to manage cash flow during periods of high and low demand is to stay prepared and make proactive financial decisions about expected cash shortages. This requires a cash flow forecast, which predicts cash inflows and outflows over a prescribed time period. It’s unlikely that you’ll forecast your cash position with 100% accuracy, but there are a few things you can do to avoid blind spots.

First, review financial statements to get a clear picture of what your sales and expenses were in previous years. It’s important to be realistic about what your operational costs are in any season. Cash flow forecasts for nonseasonal businesses also use metrics that might be misleading for your business. For example, rather than using a 12-month average forecast, use metrics such as permanent working capital and seasonable variable working capital to reflect expected peaks and valleys throughout the year.

You will also need to factor in how your business receives income, as well as how long it typically takes customers to make payments (a metric called days sales outstanding or DSO) if you don’t use point-of-sale collections. If your industry is prone to surprise cash demands or your business is due for equipment upgrades or other expenses, factor these into your forecast as well.

While it’s totally possible to create your own cash flow forecast, an accountant or finance manager — especially one experienced in seasonality — can improve your forecast’s accuracy and help you plan for sufficient year-round working capital.

2. Balance the timing of investments

Imagine that you’re in the process of forecasting your cash flow for the upcoming year and you realize that your seasonal business needs to purchase new equipment or overhaul its marketing strategy. It might seem to make the most sense to invest in these items during the slow season — after all, this is when you have more time to focus on procuring equipment or planning a new marketing initiative.

However, before you make any decisions, be sure you have the working capital needed to survive when sales are low. With a seasonal business, timing is everything — make sure you balance your expenditures in line with your cash flow forecast, saving new investments for when you actually have cash coming in.

3. Establish an effective inventory management plan

Inventory management is crucial for seasonal businesses that sell physical products. When your sales are condensed into such a short time period, you need to have enough inventory to meet demand — but not so much that you’re heavily discounting overstock or paying for additional storage in the off-season. Some best practices for seasonal inventory management include:

• Reviewing inventory needs from past years and predicting demand, similar to a cash flow forecast.

• Using your cash flow forecast to budget enough working capital for the peak season’s expected inventory demands. Consider allocating a percentage of your sales each year specifically for inventory purchases.

• Renting on-demand storage solutions to reduce off-season inventory costs.

• Partnering with suppliers or raw material providers that are flexible and can adapt to your seasonality.

If you’re concerned about cash flow, one seasonal business investment you might want to purchase is an inventory management system. While you can practice inventory management manually, investing in the right software will help you optimize the process and avoid mistakes that could end up costing you in the long run.

4. Monitor accounts receivable closely

One of the reasons why seasonal businesses fail is that sales often get tied up in accounts receivable as working capital depletes. Even if your sales are peaking, you might run out of the cash needed to cover operating expenses and inventory if those sales aren’t turning into cash quickly enough.

This is often the case for businesses that invoice their customers and have payment terms of 30 days or more. During a seasonal crunch, 30-day payment periods can make or break your business. On a daily basis, keep a close eye on your accounts receivable to ensure your customers are making timely payments. The sooner your customers make payments, the more you can grow your working capital and handle peak seasons with confidence.

If you need customer payments faster, there are some simple steps you can take to minimize payment periods — such as renegotiating payment terms or reviewing invoices more carefully to avoid time-consuming errors. One of the most effective ways to boost working capital is by using early payment incentives, which enable you to receive early customer payments by offering a small discount. This is often more cost-effective than other working capital financing options — and if your seasonal business has large customers such as a major retailer, it’s possible that they already participate in an early payment program.

The takeaway

Seasonality has a significant impact on a business’s liquidity. Between two businesses that generate the same amount of annual profit — one seasonal and one not — the seasonal business will almost always require more working capital to navigate highs and lows in demand.

Best practices such as inventory management and cash flow forecasting can give you the extra working capital needed to keep operations running smoothly. After examining your forecast and considering all the cash optimization strategies mentioned above, it’s possible that your seasonal business still needs more working capital to bridge cash gaps.

Traditional financing options such as short-term bank loans can help fund your business, but they’re often expensive and hard to secure — especially if you’re a small to mid-sized business. Thankfully, alternatives such as early payment platforms can boost your working capital without requiring you to take on any additional debt.

Learn more about using C2FO’s Early Payment program to optimize your seasonal business’s cash flow.