The word “inflation” can sure sound threatening to America’s economy. It means that things get more expensive, and consumption could fall.
This could lead to some firms seeing a decline in sales as demand slackens. Could this mean lower revenue, a reduction in profit, and a cash shortage in your business?
Thankfully, there are ways in which your company can lessen the negative effects of inflation.
In this post, we’ll address three important issues:
- What is inflation?
- How does inflation affect businesses?
- Tips for surviving inflation
What is inflation?
Here’s an easy definition from the Federal Reserve that is simple and easy to understand:
Inflation is the increase in the prices of goods and services over time.
In other words, inflation results in a wide range of products and services getting more expensive; in turn, this could mean people will buy less.
But you could be surprised to know that inflation has its positive aspects. The Board of Governors of the Federal Reserve System aims for an inflation rate of 2% per year. That’s the level at which the Fed’s maximum employment and price stability targets are most likely to be met.
Is inflation good or bad?
As we just mentioned, an inflation rate of 2% is considered ideal and can help the economy. The problem starts when the rate climbs higher than that.
And we’re currently witnessing significantly increased levels of inflation. For example, over the last 12 months, the Consumer Price Index for all Urban Consumers rose by 5% (as of May 2021).
Here’s a chart from the St. Louis Fed that illustrates the steep rise in prices in the last year. You can see that prices have risen from 256 in May 2020 to 269 in May 2021.
What’s behind inflation this year
Now let’s address another couple of questions.
When does inflation occur? Why are prices shooting up currently?
Several factors have contributed to the recent increase in the Consumer Price Index. Energy costs have shot up by 28.5% over the last year. In the same period, the cost of used cars and trucks has risen by 29.7%.
The reason behind this inflationary trend isn’t hard to see.
A year ago, in May 2020, energy prices had slumped as people stayed indoors because of the COVID-19 crisis. Now they are coming out in droves, pushing up both gas and used vehicle prices.
But what does one thing have to do with the other? Isn’t it a good thing that people are spending more money than last year?
Well, what happened is that, during the 2020’s stay-at-home orders, everything stopped: no one was going out or buying stuff, factories and businesses were also closed, production came to a halt.
But the economy began to recover, the population started getting vaccinated, and stimulus checks were issued: people began to return to their normal shopping habits.
The demand for products skyrocketed overnight.
So, factories could not generate as much raw material or products, especially since this increase in demand would be short-term (it was going to normalize at some point). That led businesses not to increase their production. In essence, there were many buyers fighting for very few products.
And as you well know, being a business owner, the law of supply and demand is the reigning law. So prices of raw materials rose, causing product prices to rise as well. And that led us to inflation.
There’s been an upsurge in the costs of many products and services. For example, flights are more expensive now than they were a year ago. So are household furnishings, new cars, rental cars, and clothing.
How does inflation affect businesses?
Rising prices can create difficulties for small business owners.
- It can get more expensive to run your business
- You may need to pay higher sums for raw materials, and specific items may be in short supply
- You could also face rising employee costs
- Clients may not be able to buy as many products or services as before
Here are the findings from a recent poll conducted by Alignable, a small business referral website:
- Two-thirds of business owners say that inflation could affect their recovery from the COVID–19 crisis.
- Many company owners are concerned that shipping costs have risen in the last 12 months.
- A common complaint is that supplies are hard to find, and when you do manage to locate them, they cost significantly more than they used to.
Inflation and interest rates
If the inflationary trend persists, it could also mean higher borrowing costs for business owners.
As the inflation rate increases, banks, and other financial institutions could start charging customers more. But what effect does inflation have on interest costs, and why?
In an inflationary situation, a dollar buys less than it used to (everything is more expensive). So, there’s a decline in the real rate of return that financial institutions earn on their loans.
Here’s how this works.
Say you borrow at an interest rate of 9% per year, and the inflation rate is 10%. This means the real rate of return for the bank is negative: they’re losing 1% on every dollar they lend. So instead of making a profit on their loans, they’re incurring a loss.
What will banks do? They’ll raise lending rates, and this will lead to more expensive loans for business owners. So business owners must take measures to protect themselves from higher lending costs.
While everything we’ve discussed paints a negative picture, you can combat these effects. We’re going to tell you the steps you can take to fight inflation.
5 strategies to survive inflation
Fortunately, there are several things you can do to protect your small business from the harmful effects of inflation. If you take these measures, you could ride out the inflationary period and even increase your profits.
Here’s what you should do:
1. Take some advice from the world’s richest investor
Warren Buffett is worth over $100 billion. He’s built his wealth by investing in different businesses over his 90-year lifetime.
A couple of months ago, he pointed out that inflation can pose a threat to business owners. He compared the challenges posed by inflation to “running up a down escalator.”
But Buffet also had great advice for businesses facing inflation:
Invest in yourself and be the best at what you do.
This means that you should always make sure to increase your knowledge, which will allow you to better understand finances and the market, so you’re always prepared. Use online resources or traditional courses to improve your financial and business education.
His other tips include getting into a business that finds it easy to raise prices and limit your expenses.
How can you translate Buffett’s advice to you and your business?
Keep reading to find out.
2. Rethink your pricing strategy
Find a way to pass on your increased costs to customers. This, of course, means that you increase your prices. But some businesses can’t raise their prices or else they’ll lose clients. If you have products that you simply cannot sustain a price increase, try diversifying your offerings.
You could do this by announcing a new range of products that give you higher margins. Or you could target a new customer segment that’s less sensitive to prices.
Higher prices to the public mean you won’t incur a loss.
However, there’s something you need to watch out for when you’re raising prices. Keep a close watch on your competition. If your products are priced higher than theirs, you could lose business.
You could even apply a loss leader strategy and decrease the price of one of your star products. This will lead people to your doorstep and, while they’re buying the start product, they’ll also buy other stuff that might be a bit more expensive.
3. Focus on expenses
Now’s the time to cut back on non-essential expenses. Review your production costs carefully and think of ways to economize.
Every dollar saved will add to your bottom line and strengthen your cash flow.
You should always strive to improve your processes and reduce wastage to spend less and win more. That’s exactly what a strategy, called lean management, is all about.
Don’t forget to keep a cash buffer. You can do this by raising a low-cost business loan.
4. Think of ways to boost sales
This might sound like an obvious thing but bear with me.
One way to increase sales is to concentrate your marketing efforts on your existing customers.
Many business owners feel that marketing to existing clients means spending money without seeing much returns, so they decide to market to new clients only. But there’s nothing further from the truth.
According to Forbes, attracting a new customer can cost 5x more than retaining an existing one. And increasing customer retention by 5% can grow profits by 25% and even to 95%
Give this strategy a try. You could be surprised by the results!
5. Plan ahead for your cash needs
Review your finances carefully. Will you need extra funds three months from now? Six months later?
Don’t leave things at the last moment. Instead, consider raising a business loan now.
Investing now in your business will allow you to grow today so that you can weather tomorrow’s storm.
At Camino Financial, we specialize in funding small businesses, we offer low-interest rates, transparent pricing, and there are no hidden costs. We say YES when others say No.
The bottom line
Inflation can be bad for businesses. You may face rising costs and declining profits. But there are ways to overcome the adverse effects of inflation. Focus on increasing sales and cutting costs.
If you want to learn more about becoming a successful business owner, we invite you to subscribe to the Camino Financial Newsletter. It’s an important part of our effort to live by the philosophy in our motto, “No business left behind.” Our newsletter will provide you with financial tips and ways to strengthen your company and boost profitability.
We look forward to welcoming you to the Camino Financial community!