Very few businesses have steady and equal activity each month of the year. As such,
it’s critically important to understand the seasonality of any business you may be buying.
The obvious issue of course is the working capital requirements when you take over a business.
First, let’s define “Working Capital”. In accounting terms, it’s the company’s total current assets (i.e. cash, accounts receivable) less its current liabilities (payables). The only problem with this formula however is that in most small business purchases, the seller takes the receivables and pays off the payables at closing to deliver the business “free and clear”. Or, in numerous businesses, there may not be much in the way of current assets.
So here you are on day one and you start incurring expenses. However, what if the Revenues during the immediate period don’t generate enough to cover them? Simple, you have a shortfall and you had better have ample capital to fund the loss or you will be out of business faster than you got into it.
I don’t want to scare you; I want to prepare you. The first thing you must do is consider the seasonality of the business. Using historical financials get a very clear understanding of what the business will generate each month/quarter as a percentage of the total sales. Then break it down further to the Gross Profit amount (i.e. after you pay for the inventory or other Cost of Goods Sold). This amount represents what you will have available to pay your bills.
I always recommend anticipating a decline in the revenues for a 3-6 month period after a new owner takes over a business. I do this because (a) it usually happens as a new owner familiarizes themselves with the business and (b) to be ultra-conservative.
calculate your potential expenses.
Again, it’s recommended to do it on both a monthly and quarterly basis.
Then, it’s simple math: will you have adequate cash to cover costs? If no, you will need to inject additional capital or arrange a working capital loan.
One of the things you should do is to itemize every expense and see which ones can be deferred.
Typically, these are ones associated with the sale such as the principal and interest due on any note associated with the sale. Negotiate a payment holiday for the necessary amount of time.
In highly seasonal businesses, you can, where possible, negotiate to have the seller leave an amount of working capital to get over the difficult period.
Keep in mind however that except for very large deals, you will likely have to pay back part or all of it.
You may be saying that you’ll simply buy the business during its historical best periods. Great idea! Unfortunately, it doesn’t always work and you may be sitting around while the seller finds another buyer. Further, talking over a business in its peak selling season can prove to be a horrendous way to learn the business. Personally, I prefer starting when it’s quiet so I can learn the business properly in order to be fully trained and prepared for the peak season.
To summarize: get a very clear handle on how the business breaks down percentage-wise month by month. Understand your expenses. Be realistic in projecting sales – remember it’s always better to be conservative. If sales exceed projections it’s very easy to live with the scenario, but not so if they fall short.
If you do your projections properly, you almost always can have some leverage and support from the seller since they too know the seasonality issues the business faces. Most importantly, make sure you have adequate reserves or access to some. Remember the old adage to “save for a rainy day”. If you go into a business undercapitalized that rainy day will quickly become a monsoon.