High inflation: What does it mean for your business?
High inflation: What does it mean for your business?
Inflation is hitting businesses hard, and many are struggling to keep up. With prices rising, customers are spending less and businesses are making less profit. So what does high inflation mean for your business? Here's a quick rundown of how inflation can impact your business, along with some tips on how to stay afloat during these tough times.
What is inflation?
We are currently witnessing a dramatic surge in inflation due to numerous causes. Inflation is defined as an overall climb of prices, which leads to the devaluation of money when measured against goods and services. Typically, prices rise over time, but prices can also fall (a situation called deflation).
What happened that caused this high inflation environment?
There are many factors contributing to this current issue but here are some of the main ones:
- The Reserve Bank of Australia's Quantitative Easing program was a critical component in the economic recovery from COVID-19. By purchasing government bonds, the RBA effectively injected money into the economy and significantly alleviated some of its effects. Although this program concluded in February 2022, its impacts remain prominent to this day.
- The recent COVID-19 pandemic has been especially hard on the supply chain, causing shipping and manufacturing delays that have left us with fewer goods available. Consequently, this scarcity of resources has caused prices to soar.
- To invigorate the economy and stoke demand, the government issued a slew of COVID-19 stimulus packages like the JobKeeper scheme. This injection of liquidity into circulation is aided in driving up inflationary pressures in both consumers' wallets and businesses alike.
- The turbulent conflict between Ukraine and Russia has caused a surge in commodity prices, with several countries' sanctions drastically driving up the cost of oil and gas.
Latest figures from ABS show that the inflation rate in Australia has risen to 7.8%, which is far more than the RBA’s target of 2-3%. The IMF are expecting rates to above the target until 2024.
Rising interest rates
Inflation and interest rates are inextricably linked. The Reserve Bank of Australia (RBA) has a 'cash' rate which it can modify to control inflation if it runs too high. By changing the cash rate, the RBA is able to rein in rising prices so that they remain steady or decline over time.
Since the record low of 0.1% in November 2020 the RBA has increased the cash rate to 3.10 as of December 2022. Many sources are anticipating interest rates to continue increasing for the foreseeable future while the inflation rate continues to remain high.
Record low employment
Australia’s latest unemployment rate stood at a 50 year low of 3.5%. This is largely because of the pandemic, as border closures and uncertainty caused some of Australia’s workforce on temporary visas to leave the country, while Australia’s soaring debt level has fuelled a rapid rebound.
6 ways inflation affects businesses?
1. CPI increases
If consumers are paying higher prices for goods and services, the Consumer Price Index (CPI) will also increase. This, in turn, can lead to rising costs, and a decrease in buying power for consumers and businesses alike.
2. Disrupted supply chains
When the supply of raw materials needed for their products decreases and the demand for the products remains the same, this shortage of material can cause supply chain disruptions for a company.
And with fewer goods available, businesses may find themselves paying more for whatever amount is left—often driving up the price of the finished product as well. This type of inflation is called demand-pull inflation.
3. Shortage of raw materials
As businesses seek to source materials at the lowest possible cost, they may inadvertently create shortages of raw materials. This can possibly lead to production delays and a decline in revenue.
4. Higher borrowing rates
When inflation goes up, so do interest rates. This is because central banks like the Reserve Bank of Australia use interest rates as a tool to prevent runaway inflation and economic growth.
Interest rates determine how much it costs to borrow money through, say, loans or lines of credit. Less money borrowed means less spending power for businesses and consumers, and this works to reduce the demand for goods and services throughout the entire economy.
But because higher interest rates are a direct result of inflation, this makes it more expensive for companies to borrow money as well.
5. Decreased consumer spending
When businesses increase their prices to account for rising costs to produce or sell their offerings, they essentially pass these costs on to their customers. This often reduces consumer spending for the product or service in question and angers some buyers.
Like with businesses, high inflation rates become a burden for consumers who struggle to pay for the essentials they need to survive and lead a meaningful life.
6. Old debt becomes cheaper
As inflation goes higher, the value of debt decreases. This can be beneficial for businesses as it makes it easier to repay old debts. While old debt becomes cheaper, new debt becomes more expensive, leading to higher borrowing costs for businesses and a decrease in profitability.
How business owners can reduce the impact of inflation
As a business owner, inflation can have a detrimental effect on your bottom line due to increased costs of goods and services. The key to avoiding the resulting losses is proactively implementing strategies that reduce the impact of inflation.
Although you can’t control inflation, we have some good news, you do have some control over how it affects your business. Keep reading below for 7 strategies to help safeguard your company from rising costs in the months ahead.
1. Reassess Your Prices
Despite the problems they can cause your business, periods of high inflation are a great time to review your pricing strategy and decide whether to raise prices to match the current inflation rate.
To assess the situation, initially compare what you have available to offer and your prices with those of your competitors. Are the products or services that you provide superior quality yet more affordable? If so, there is a likelihood that customers will be content with accepting an increased cost due to receiving greater value from you.
Of course, if the cost to deliver your goods or services has gone up, it may be wise to raise prices to protect your business and keep up with the latest economic changes.
But if the idea of raising prices makes you feel uneasy, know that other businesses are doing the same. In its second quarter Main Street Index, financial firm CBIZ revealed that 61% of Main Street businesses increased the prices of their offerings by at least 5%, while another 29% raised them by 10% or more.
When you roll out price increases to your clients, be sure that the way in which you communicate these changes is done delicately so as not to alienate any of your loyal customers during a potentially delicate period for your company.
2. Buy in Bulk Ahead of Time
For all of their benefits, just-in-time (JIT) supply chains may actually hurt your business during periods of increased demand and low supply.
If you have the funds to do so, make a point to purchase supplies or materials that are critical to your business in bulk ahead of time, rather than restocking or repurchasing when needed.
During times of inflation, the cost for materials can skyrocket and supplies could run out suddenly. Purchasing ahead in bulk will guarantee you have a continuous supply to meet your manufacturing needs, giving you an advantage over other competitors who weren't as prepared.
More advantages come with this approach. Buying in bulk guarantees that all of the necessary materials arrive simultaneously, decreasing your chances for shipping delays. Furthermore, you could potentially haggle a lower price with vendors when purchasing large amounts of goods.
3. Reduce Expenses
Inflation can quickly raise prices for goods and services, making it critical to store a reasonable amount of cash. When your funds are tied up in assets that cannot be easily converted into money, you'll face difficulties when needing extra funding or wanting to take advantage of an opportunity with short-term duration.
If you haven’t already, make sure you understand how much your business needs to stay afloat during these uncertain times. (And if you haven’t made adjustments to your calculations to account for the current economic climate, now is the time.)
Next look for ways to cut costs and reduce unnecessary spending so you can save more money for when you need it.
Prioritize your current business objectives while taking into account future plans by consolidating or paying off debts to reduce loan repayments.
4. Be Proactive in Securing Business Funding
Because central banks use interest rates as a way to combat inflation, it’s essential to think ahead if you plan on borrowing money for your business now or in the near future.
Take this opportunity to lock in a lower interest rate now by taking out a small business loan or line of credit, as mentioned earlier. Doing so will help you save money and likely reduce your overall cost of borrowing over time.
5. Reevaluate Your Product Offerings or Revenue Streams
As an alternative to raising your prices outright, you may decide to focus your efforts on selling goods and services that are more popular with customers or boast higher profit margins.
Start by looking at your offerings and determine which ones have been most profitable for your business. If you’ve also been affected by higher costs, now is a great time to see which ones currently have lower profit margins.
Think of how other contributing factors like supply chain issues or employee turnover can hinder your capacity to offer your products and services in the present economy. If necessary, discontinue lower profit outputs so you can reallocate resources towards those that bring in more money for your business.
6. Outsource Work for Greater Efficiency and Productivity
During periods of high inflation, businesses must be strategic with their funds. To maintain financial stability while continuing to thrive, it's best to keep your operations as lean and efficient as possible. Review both pricing strategies and product offerings for potential changes that could prove beneficial in the long run, but also think outside-the-box: how can you do more in your business without having to spend excessively?
For instance, The Harris Poll found that 27% of companies surveyed adopted technology to automate their processes. Another 18% of respondents outsourced some of their work instead.
If you haven't already, invest in new technology that will help you and your team stay on top of uncertain times. Accounting software, such as Xero, automates tedious finance-related tasks so your staff can focus their energy on higher value initiatives—which allows them to finish more work faster and with fewer costs.
Plus, with automated systems in place, you can rely on these tools to keep your business running smoothly, even during times of rapid change or high employee turnover.
Today, you have the opportunity to leverage the booming gig economy for your business’ benefit. You can hire freelancers or consultants to manage much of your work without incurring a full-time employee's overhead costs. They come with their own specialized skills and upfront fees that make them perfect as an addition to your in-house team!
7. Diversify Your Entire Supply Chain
Try not to put yourself in a position where you rely on just one supplier or vendor for your materials. Businesses across the globe saw their supply chains decimated at the start of the COVID-19 pandemic as their suppliers also experienced issues.
Having multiple suppliers on your side provides a great advantage if one of them is delayed or raises their prices. During times of economic inflation, you can also leverage this to negotiate for more cost-effective rates and better terms with each supplier. This way, you will be able to get the most out of your partnership and protect yourself from any sudden shifts in market conditions.
Are there any positive impacts of inflation on businesses?
We often recognize inflation’s unfavorable consequences on businesses, but surprisingly enough, it can also have positive outcomes. Check out these five beneficial impacts of inflation:
- Increased bottom-line: With the right approach, inflation can translate to profit. Businesses often feel the impact of rising prices in labor, materials and energy costs, yet these increases don't have to be a burden – they may become an asset if businesses pass them onto customers by raising product or service prices appropriately. This way businesses are able to maximize profits.
- Reduces debt burdens: Inflation lessens existing debt and provides more financial freedom to businesses. This not only diminishes the burden of current obligations, but it also encourages further borrowing which can result in more investment opportunities and expansion.
- Efficiency gains: Companies must stay ahead of the competition to remain successful in a continuously inflationary market. To do this, businesses should maximize their efficiency and productivity - steps that can prove fruitful over time.
- Job creation: Inflation brings about an augmented requirement for goods and services, which in turn encourages businesses to employ more workers. This can help offset the increasing unemployment that generally comes hand-in-hand with raised inflation levels; thus creating jobs!
- Encourages investment: Investment is nurtured when businesses anticipate rising prices, which can result in higher profits for them. By investing more money, organizations are actively contributing to the economy's growth and increasing job opportunities - all of which encourage even further investment.
What happens when businesses expect inflation?
If businesses expect inflationary pressures are on the way, they need to take steps to protect themselves. For example, they may raise prices in advance of inflation to maintain their profit margins. They may also invest in more durable goods and materials to avoid having to replace them as often and investing in assets that are expected to increase in value.
Businesses are wise to take action sooner - otherwise they could be caught unprepared with no financial buffer when inflation threatens them later.
Conclusion
Inflation can have far-reaching effects on businesses, but with the right preparation and strategies in place, you can minimize its negative impact.
If you’re concerned about how inflation may affect your business in the future, don’t hesitate to get in touch with our accountants who can help you plan for success.
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If you need more advice on this issue, please contact our team.
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