In a perfect world, companies earn revenue and generate profit consistently throughout the year. But some borrowers, such as landscapers, hotels and toy manufacturers, experience significant seasonal fluctuations in their financial performance, with most sales occurring in one quarter. Seasonal businesses still need working capital to operate throughout the year, for such items as inventory, rent and salaries — and they often need to turn to banks to fund the shortfall during the off season. Bankers can use these three approaches to assess and manage the credit risk associated with lending to seasonal businesses.
Seasonal businesses must deliver goods or services within a narrow period — sometimes in as little as a few days. With the company’s financial health dependent on flawless execution, seasonal businesses have to operate efficiently and effectively. Verify whether your seasonal borrowers have access to the people, processes and technology needed to compete in the marketplace. Their ability to earn revenue — and, consequently, service debt — depends on it.
Analyzing an established business’s historical performance, especially during the off season, provides key information regarding its credit risk. This information helps bankers evaluate loan requests. It also serves as a baseline level to monitor activity after the borrower receives the loan to ensure proceeds fund appropriate business expenses.
Given their short-term nature, most bankers treat seasonal loans as revolving lines of credit that initially require interest-only payments — and then, at a predetermined date, repayment of the principal. Some bankers provide incentives for borrowers to repay all or part of the principal balance by extending the repayment date. This phased approach allows a borrower to extend the loan while simultaneously paying down the principal over time. Meanwhile, the banker earns interest income, as well as a deeper understanding of the borrower’s operations and cash management skills.
While seasonal businesses offer enticing opportunities for bankers, they require a cautious, measured approach that accounts for their inherent credit risks. With appropriate oversight and financing, seasonal businesses can thrive, generating a consistent stream of interest income and loan-related fees.
For more information on Smith and Howard’s commercial banking services, please contact Mark Abrams at 404-874-6244.
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