Incorporating Seasonality into Financial Planning
In preparing an annual budget it is often difficult to estimate annual trends such as revenue growth, staffing requirements, additional spending or capital needs. While preparing the annual budget it is important to use prior year results, knowledge of the market, customer behavior, and an analysis of current operations. However once all the relevant factors are considered and an annual profit and loss estimate is reached for the new year, how can this be translated into a monthly budget?
A key component of this process is understanding seasonality. This factor is not only directly relevant to monthly profit and loss assumptions but also a key element of balance sheet trends. Let’s address the income statement first.
Seasonality is a recurring temporary variation in financial performance that occurs at roughly the same period every year. An example would be a nursery that experiences a significant lag in sales through the winter months but sees a spike in sales in the spring. Planning for this kind of seasonality is critical to sustaining the business. By projecting monthly revenues based on prior year seasonality, a business owner will make better decisions about purchasing, staffing and overall spending.
ABC Nursery plans overall annual sales growth from $1M in 2019 to $1.5M in 2020. Using the average of sales for January in 2018 and 2019 as a percentage of total sales, apply that same percentage of 2020 revenue to January. Continue this process for all months and the result will be $1.5M in 2020 revenue spread over the calendar months using the average per month sales percentage of the prior 2 years. Estimate costs based on historical margins, knowledge of plant costs and staffing needs. Estimate expenses based on G&A, facilities and other overhead.
With the resulting monthly income statement the company can predict potential losses in net income and the period of time to recovery. Spending decisions during the down months become critical to managing cash flows. Now let’s address the balance sheet.
The fluctuations in revenue and net income due to seasonality have a direct impact on cash flows. In slow months, it is crucial to recognize the need to monitor cash. The reduction in sales will reduce inflows and while many costs can be managed the cash flow must still cover fixed costs. In this situation it is often beneficial to get a bank line of credit. The business owner can borrow against the line as needed to cover necessary costs during the down periods and incorporate a plan to repay in the budget when the higher income periods occur and cash flow improves.
Incorporating seasonality into an annual budget will reveal a lot of critical financial information for business planning. Creating a realistic income expectation for the slower months will provide the opportunity to make better spending decisions. It will also reveal the low points in cash flow and highlight the need for spending reductions or borrowing against a line of credit. Understanding the impact of seasonality is critical in sustaining a business during both the slower and more profitable months. Make sure seasonality is incorporated into a monthly annual budget for both the income statement and balance sheet. Careful, realistic planning can make the slow months less stressful and the profitable months more enjoyable!