Understanding the Impact Inflation Can Have on Your Small Business

by Michael Brands Nov 10, 2021

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Table of Contents

The Consumer Price Index Measures the Cost of Living 

Will the Inflation Rate Decrease Once the Supply Chain Goes Back to Normal? 

How does inflation affect small businesses? 

1. Increase in prices of raw materials
2. Increase in costs of labor and overheads
3. The rising price of inventory
4. Rising interest rates
5. Rising costs of insurance
6. Rising costs of real estate

Watch the Interest You Pay on Your Loans Closely 

How Does Inflation Affect Your Current Business Finances? 

1. Have an emergency fund
2. Reducing your overextended debts
3. Changing your business strategy
4. Being flexible in your spending

Conclusion 

 

Do you know how the rising fuel costs, food, or other raw materials can affect your business or organization? The rising costs of inflation and rising wages, as well as market fluctuations, can all adversely affect the margins of your small business. In this article, we will examine how inflation can impact you and your business. 

 

Inflation is a worldwide phenomenon that has existed throughout history. When people have suffered from periods of inflation, the cost of almost everything – from food to essential services – has risen. This affects the size of the profits earned by companies. Consequently, companies have to raise prices to remain profitable against their rivals. Over time, this could lead to low profits and eventually become unsustainable. 

 

Nowadays, inflation could create a significant threat to your business. For instance, if the inflation rate is 2% per month, the price of your product will grow by 10% every year. If this trend continues, you can expect that you will face enormous financial losses. In other words, your company will experience a sharp decline in revenue. In the long run, the market shares of your competitors will take over your own. 

 

Inflation also affects the customer every time they pay for a product or service. For instance, if customers spend an extra 5% on the same product every year, the sales will be affected. Moreover, certain items are sensitive to inflation. For instance, film and cosmetics are susceptible because of their limited shelf life. This can lead to a severe loss to companies if they cannot keep their prices at the level of inflation for a more extended period. 

 

The Consumer Price Index Measures the Cost of Living 

 

The Consumer Price Index (CPI) is widely used to measure inflation. This index aims to determine the rate of inflation by comparing average costs across different sectors. It is typically organized into twelve categories. The CPI combines the prices of various goods and services. Thus, this index is used to measure the cost of living. 

 

Governments around the world frequently use the index to formulate monetary policies. In other words, government employees use this index to decide how much money should be printed and when. Governments usually do this to prevent rising inflation rates. In fact, during a period of high-rate inflation, a common practice is to reduce the number of notes in circulation. 

 

Will the Inflation Rate Decrease Once the Supply Chain Goes Back to Normal? 

 

Some economic experts believe that inflation will stabilize once the pandemic is over. Some experts predict that the price of raw materials will decrease once the crisis is over. Others predict that there will be a significant increase in commodity prices due to the production cessation. 

 

For instance, people are concerned with gold supplies. In the past, people mined gold in search of better profits. After the pandemic, gold mines will start to re-open. However, they will only process a limited amount of gold due to the high cost. Consequently, people can expect that gold prices will decrease once production is increased. On the other hand, some scientists believe that we can expect a significant increase in gold prices and the cost of silver and platinum. This is because gold producers worldwide have been producing less gold due to the high cost of production. 

 

How does inflation affect small businesses? 

 

Inflation affects small businesses in a variety of ways. Small businesses tend to be less capable of maintaining their prices in times of rising costs. They tend to respond slowly to increasing costs and changes in the economy. Below are a few ways inflation can affect your business: 

 

1. Increase in prices of raw materials

 

When costs of raw materials rise, the prices in the marketplace increase. Consequently, this can hurt your profit margins. 

 

2. Increase in costs of labor and overheads

 

Labor costs are the most significant component in most industries. Consequently, they are the first to rise under inflation. Hence, when labor costs increase, your company can experience a significant decline in profit margins. 

 

3. The rising price of inventory

 

The cost of inventory is another component that goes up when inflation affects small businesses. Inventory costs are usually higher in small businesses because they are more vulnerable to price fluctuations. 

 

4. Rising interest rates

 

When inflation rises, the cost of money itself rises. This can increase the prices of loans, especially for small businesses with weak credit ratings. 

 

5. Rising costs of insurance

 

Inflation affects the cost of insurance, such as your business's liability insurance. This may lead to a situation where you may not be able to get an insurance policy. This may lead to low sales, lower profits, and an inability to grow your business. 

 

6. Rising costs of real estate

 

Inflation also affects the cost of using real estate, such as office spaces and retail stores. Consequently, real estate owners can increase their rents. This can be a massive problem for small businesses already operating on a tight budget. 

 

Watch the Interest You Pay on Your Loans Closely 

 

The interest rate on loans is one of the significant components which affect your business's profit margins. Therefore, when the interest rates rise, you can expect that your profit margins will decrease. 

 

When the interest rates increase, it affects borrowers' ability to pay their debts. This can harm your business if merchants are unable to obtain funding because the interest rates have increased. It is worth noting that the interest rates also affect suppliers, contractors, and other parties who provide their services to you. 

 

How Does Inflation Affect Your Current Business Finances? 

 

As an existing business owner, you will have to keep up with inflation by keeping your costs at the level of inflation and increasing your sales. Otherwise, you will suffer losses in the long run. Below are a few steps you can take to help protect your profit margins in times of inflation: 

 

1. Have an emergency fund

 

You should be concerned about the cost of raw materials, labor costs, and overheads. You should always have a fund to cover these kinds of expenses. You should also try to avoid borrowing unnecessarily. If you need to borrow, try to get the loan at a low of an interest rate as possible. 

 

2. Reducing your overextended debts

 

Inflation can result in a decline in debtors' ability to pay their debts. Therefore, you should reduce your debt as much as possible to protect your profit margins. 

 

3. Changing your business strategy

 

You should be prepared to make significant changes in your business strategy. If you can't, you can always change your suppliers or analyze the production costs to cut the cost of doing business. 

 

4. Being flexible in your spending

 

Do not automatically spend your budget. You should be flexible in your spending when prices go up. You should also make sure that you don't overspend to protect the profit margins of your business. 

 

Conclusion 

 

Inflation affects businesses in a variety of ways. There are many strategies you can use to safeguard your company's profit margins. You can also reduce your costs of doing business. However, the most important thing is to be prepared for rising costs so that you can protect your business from inflation. 

 

Inflation is another one of those things that businesses have to deal with, such as labor shortages, the cost of energy, and changes in the global economy. For business owners, inflation is something that they have to deal with several times throughout the lifespan of their business. 

 

You shouldn't see inflation as the end of your business, but as a challenge, you must overcome. In this article, we have looked at how inflation can pose a challenge to a business owner. We have also provided several ways to overcome inflation. You need to protect your profit margins from inflation if you want to increase the chance of your business surviving.