Inflation is a big buzzword in 2022 which is important to understand especially as a business owner. Understanding inflation will also help you plan for it accordingly. If you own a small business or are thinking of starting one, you need to learn how inflation may affect your venture.
Let’s dive deeper into inflation: what it is, how it affects small businesses, and the challenges it presents in 2022. Plus, we’ll explore some tips on how to structure your business’ finances to lessen the impact of inflation.
What is inflation?
Inflation occurs when the price of goods and services rises, lowering the purchasing power of the dollar—and the potential profits of businesses. For example, say you’re able to purchase 100 Widgets for $100. If, a decade later, your $100 only buys you 50 Widgets, you effectively have 50% less purchasing power. This is a very basic, simplified look at inflation. The cost of Widgets went up, which drove your buying power down.
Each year, the United States’ inflation rate hovers around 2-4%. This is considered “healthy” inflation, because it means the value of goods and services are increasing as the economy expands. However, in 2022, we’ve seen monthly inflation rates above 6-8%, which means prices are rising too high too fast.
Inflation affects markets and sectors differently. For instance, the cost of building products rose by more than 30% between 2020-2022. Meanwhile, the cost of food products rose at about 16% over that same time period.
How does inflation impact small businesses?
Inflation affects every business, big or small. Specifically, it affects the Cost of Goods Sold (COGS) for a business. For example, if you buy raw materials to make Widgets and the cost of those materials rises, it now costs you more to produce Widgets. You’ll need to sell them at a higher price to justify the higher COGS—or, lose your margins by selling them at the same price. The same goes for service-based businesses, as well. As prices rise, so does the cost of human capital. You need to pay people more to work so they can afford the rising cost of goods.
For small businesses, inflation can quickly cause problems. Small businesses can’t lean on economies of scale like larger companies can, and they might not have the strong cash flows or reserves of more established companies. To tackle inflation in business, smaller companies need to act nimbly and operate efficiently. If the impact of inflation is to drive prices up, small businesses need to find ways to bring it down.
What can you do to offset inflation and lessen the load?
Battling inflation can seem like a monumental task for small businesses. To overcome it, you need to first understand how inflation impacts businesses. Then, you need to look at your own situation to identify opportunities. Here are some tips for lessening the load:
- Assess margins and raise rates. As mentioned, businesses often need to pass on increased COGS to consumers. This means raising prices. Don’t just raise your prices at random, though. Understand the true cost of inflation on your business model and raise prices to stay ahead of it. For example, if your COGS are up 8%, consider raising prices 9-10%. Don’t get greedy or you could lose customers.
- Find ways to reduce costs. Are there ways that you can reduce your operational costs? Are there opportunities to create efficiency or leverage economies of scale in your business? In addition to raising prices, explore ways to lower costs. Lowering operational costs can reduce the amount you need to pass on in price increases or help preserve your margins as you re-tool your pricing model.
- Be strategic in your finances. The effects of inflation on business demand a shift in how you think about your cash flow and finances. In an inflationary environment, you’ll want to alleviate debt, build cash reserves, fund smart investments, and lean on strong revenue streams. As the purchasing power of the dollar falls, businesses need to find ways to preserve it by making their money work for them.
There is no silver bullet for small businesses when it comes to fighting back against the impact of inflation. It’s best to work with a financial advisor that can provide tailored advice that puts your company in a position to weather the current environment.
Manage your finances with NorthOne
One thing every small business needs when it comes to battling the effects of inflation on business is the peace of mind that comes from working with a financial institution that supports them.
At NorthOne, we understand how inflation impacts businesses and we’re constantly working to help our customers navigate the challenges associated with rising prices. Learn more about how we can help your business establish strong financial foundations that weather inflation.