The holiday season is profitable for many businesses, and profitability is essential for survival for businesses that rely on holiday sales and revenue to sustain business operations throughout the year.
Unfortunately, poor cash flow and inventory strategies can easily derail a short-term windfall. Now is the time to take a look at avenues to improve cash flow and inventory management, even if you think you’re financially sound in these areas.
Some key takeaways:
- Cash flow management requires proactive planning and forecasting to avoid post-holiday shortfalls.
- Changing your inventory accounting method can make a big difference in your cost of goods sold (COGS), but you may need professional help to do it.
- Seasonal adjustments and contingency plans protect against the January cash crunch that follows holiday sales.
First, let’s get an understanding of the most common December cash flow problems.
Cash inflows in December depend on cash outflows in September and October. Those are the months when businesses buy inventory to sell during the holiday season. So, a wrong move in the buying phase can lead to a revenue shortfall during the selling phase. That’s your first cash flow challenge.
Inventory costs typically increase due to inflation. This year, US tariffs on imports could further raise those prices. You’ll need to charge your customers more to make a profit. Will that impact your holiday sales numbers? There’s a good chance that it might. That’s your second cash flow challenge.
Balancing inventory costs with retail prices is problematic for businesses operating on thin margins or those without sufficient capital reserves; this issue is especially complicated for B2B companies reliant on client invoicing and retail companies dealing with credit card processing delays. Either could widen gaps between accrued revenue and actual cash receipts. That’s your third cash flow challenge.
Increased sales revenue will not outpace cash flow shortfalls, so what’s the solution?
It’s tempting to believe that increasing sales will eliminate cash flow problems, but that’s not usually the case. Higher revenue means higher costs, as I demonstrated above, and the timing mismatch of payments can be problematic.
The solution lies in changing systems and processes. Here are strategies to manage increased holiday cash flow more effectively:
1. Accelerate receivables wherever possible.
Offering small discounts for customers to pay early can help shorten the gap between invoicing and payment. Keep in mind that this will also decrease revenue, so limit the discount to a small percentage. For optimal results, consider combining this process with shorter payment terms for new customers and upfront deposits for large orders.
2. Negotiate extended payment terms with your suppliers.
Accelerating receivables can increase cash inflows. Negotiating new terms with vendors and suppliers decreases cash outflows. If your vendor typically requires payment in 30 days, ask for 45- or 60-day terms. This is particularly useful when you’re buying October inventory that will sell in December. Think of it as timing outflows to match inflows.
3. Create a detailed cash flow forecast model.
Direct cash flow forecasting tracks actual cash receipts and payments as they happen. It’s more accurate than indirect cash flow forecasting in short-term situations, but it may not account for dramatic revenue increases around the holidays. Predicting that requires tools that may be available in your accounting platform. Better yet, contact my office for help with this.
4. Set aside reserves for post-holiday obligations.
That extra revenue in December needs to cover payroll, rent, quarterly tax deposits, and other operating expenses in January. You’ll want to put aside 25% to 30% of your profits to cover those expenses. Revenue after the holiday is likely to decline, so don’t rely on that to bail you out. Sadly, many small and first-time business owners make this mistake.
5. Consider establishing a line of credit before you need it.
Seasonal businesses often set up a business line of credit to cover expenses during their off-season. Year-round operations can employ a similar strategy to survive the holiday cash flow. You could also use it to purchase inventory now without tapping into your cash reserves. Just remember that there’s an interest cost to do it this way.
How can we prepare for lower-than-expected revenue?
Let’s talk about what happens if you miss your holiday revenue targets. Consumer demand could change, economic circumstances might decrease holiday spending, or any number of unforeseen factors could disrupt your holiday revenue stream. Here’s how to prevent that:
1. Identify non-essential expenses you can cut quickly.
This should be a standard practice throughout the year. It’s essential in the fourth quarter. Limit discretionary marketing spending, equipment upgrades, or elective professional services. It’s best to sit with your accountant and make lists of “essential” and “non-essential” expenses. This is also a good way to start building a new budget for next year.
2. Maintain open communication with vendors and creditors.
I alluded to this above. Your vendors and creditors might be willing to renegotiate the terms of your payment agreements. Maintaining open communications throughout the holiday season allows you to have those discussions when you see a cash shortage coming. The earlier you can do that, the better your chances of having a favorable outcome.
3. Consider promotional strategies to move inventory.
Unsold inventory is an asset on the balance sheet, but a liability when you need cash flow. A well-timed sale can turn that inventory into cash flow. There’s no need to panic and slash prices so low that there’s no margin left. Start by discounting slower-moving items. Create some urgency with limited-time offers. Many companies do this in early January.
4. Preserve your cash reserves during slow periods.
Make it a habit to keep your cash reserves in reserve rather than spending them to cover expenses. If revenue is down, adjust your spending. Using that money for anything less than an emergency can be a crucial mistake. It can also mask operational shortfalls. You’ll want to identify and address those as soon as possible.
Adopt best practices for inventory management.
Changing your inventory accounting method can make a big difference in your cost of goods sold (COGS), but it isn’t something you can do on a whim. You’ll need to file IRS Form 3115 to change from LIFO to FIFO or vice versa. I strongly recommend that you speak with me about that first. In the meantime, try the following inventory management strategies:
1. Stock based on historical sales data, not optimism.
Savvy business owners base purchasing decisions on data. That means pulling reports from past years to analyze sales from previous holiday seasons. It’s not a good idea to buy more inventory because you have a “gut instinct” that sales will increase. You’ll also want to analyze data on new product lines, consumer behavior trends, and new customer profiles.
2. Avoid over-purchasing.
Excess inventory ties up cash that could be used for other purposes. Knowing what your inventory turnover rate is can help prevent that. You can calculate this metric by dividing your cost of goods sold (COGS) by the average inventory value.
A higher ratio means you’re selling your inventory quickly and efficiently. A low ratio could mean you’re overstocked.
3. Track sell-through rates in real time.
Don’t wait until December 26th to realize half your holiday inventory isn’t moving. Your point-of-sale system should allow you to monitor sales velocity. Real-time data can help you adjust pricing or create promotions to improve your numbers. If it still doesn’t move, you might need to adjust your inventory-buying strategies.
4. Plan for post-holiday clearance and returns.
Consumers often wait until after the holidays to take advantage of clearance sales. You should plan on having one, but don’t promote it too soon. Customers won’t pay full price if they know something’s going on sale. Retailers should also assume a certain percentage of holiday sales will be returned. According to the National Retail Federation, that number was 17% last year.
5. Use industry-standard inventory management software or accounting platforms.
QuickBooks, FreshBooks, and similar platforms integrate inventory tracking with your financial statements. They calculate the cost of goods sold automatically, alert you when stock runs low, and provide reports on your best and worst performers. Those insights are useful for making a wide range of inventory management decisions during the holidays.
6. Coordinate inventory purchases with cash flow projections.
Before placing a large order, check your cash flow forecast. Can you afford to pay for this inventory and still cover payroll and other obligations?
If the answer is no, consider splitting the order or negotiating different payment terms. Never assume the inventory will sell quickly enough to cover the cost of purchasing it, especially if historical data tells you otherwise.
What’s your next move?
The holiday season offers a tremendous opportunity for small businesses if they manage the financial side as carefully as the operational side. Balancing cash reserves with inventory needs is what separates businesses that thrive from those that struggle after the holiday season.
Start your cash flow forecasting in November, and review your inventory management approach before you start purchasing holiday stock.
If you feel your business is not managing seasonal revenue and sales cycles effectively, contact my office for financial and accounting solutions.
Cash flow and inventory management require accounting and financial expertise. You may have some of that at your firm, but an outside professional can give you an unbiased analysis of your holiday strategies. Schedule a discovery call today to get started.
Talk soon,
Jeremy A. Johnson, CPA