What is Inflation and How Does It Affect Small Businesses?

This article was updated on March 15, 2023

Note to Reader: On December 7, 2022, the Bank of Canada raised interest rates to 4.25% — the seventh time the bank has raised rates this year. This new rate is the highest rate Canadians have seen since 2008 and the fastest rate jumps since the 1990s.

Economic anxiety has gripped the country, according to the most recent Ipsos poll. In the December 2022 survey, 86% of Canadians replied they’re either somewhat worried or very worried that a recession is on the horizon. Fifty-three percent expressed concern about food prices and being able to feed their families.

These surging rates don’t just affect families; they also affect the local businesses that serve them. Supply and wage costs continue to rise in the aftermath of rate hikes. Thirty-seven percent of small business owners say inflation is significantly impacting their businesses.

The top three challenges they cited? Rising interest rates, labour market shortages, and difficulty sourcing products due to the ongoing issues in the supply chain. Many supply chain issues are occurring for the other two reasons — it’s all connected.

Inflation is the greatest agitator of economic fearfulness — but what is it exactly? And how can you and other small businesses make it through a rough patch?

What is inflation?

Inflation is the rate of increase in prices over a certain period of time. Inflation measures this increase over a set period, usually a year. This is typically referenced as a broad measurement that reflects the cost of living in a country, for example, but can also be used to refer to micro measurements, such as the rise in the price of raw materials. When the money supply for a country grows too big relative to the size of the economy, the unit value of the currency diminishes. In other words, the value of a dollar decreases as the price of goods and services increases — it’s essentially the law of supply and demand. This makes it increasingly expensive for consumers to purchase goods and services as inflation continues.

How might inflation affect small businesses?

Small businesses today are looking closely at expenses as they navigate higher inflation, supply chain shortages, and labor issues. According to Statistics Canada, while many businesses raised prices throughout the pandemic, only 34% of businesses surveyed in Q3 2022 expected to raise prices in Q4. That’s still over one-third of all Canadian businesses, citing rising inflation, transportation costs, insurance fees, and costs of sourcing materials as obstacles. For instance, raw material prices soared over 19% between July 2021 and July 2022 — and that was on the heels of a more than 32% increase in prices between June 2021 and June 2022.

Let that sink in for a moment — between June 2021 and July 2022, the price of raw materials jumped 51.5%. For the businesses that rely on these materials, survival means passing these costs on to the consumer, unfortunately, in the form of more expensive goods. Otherwise, the business could experience serious cash flow problems.

Here are a few ways inflation might impact your business’s cash flow:

• Increased costs: Costs of supplies or services to run a business may increase due to inflation.

• Raised prices: With recent labour shortages and supply chain issues, some businesses are experiencing an increase in the cost of goods sold. If costs to supplies, raw materials, or services increase, this could, in turn, mean businesses must consider raising prices on their products and services to offset these rising costs.

• Narrower profit margins: Profit margins, impacted by raised costs, could narrow. For businesses, this may mean making changes to better manage cash flow, forecast profit margins, and calculate break even points. By maintaining current profit margins during times of inflation or finding opportunities to increase them, you can continue to chart a path to profitability.

• Reducing or changing inventory: Modifying inventory can be an opportunity to save on costs. Some businesses may choose an inventory management style in which they maintain the minimum product counts required to keep customers happy. This inventory management style also saves on storage costs. Others may instead source locally, potentially saving on costs to transport materials and supplies.

Use the ideas above to keep your costs as low as possible — for you and your customers.

A few cash flow management tools

The effects of inflation on a business can have many factors — from what type of business you operate, the goods and services you offer, or where you’re located. Despite this, there are some ways to actively manage your cash flow and help forecast your business’s finances and decisions you may need to make.

• Tracking expenses. Integrating an expense-tracking app with your point of sale (POS) or accounting system can help you stay on top of your business’s income and outflow. In addition, consider other accounting and tax tools to help you see a more holistic financial picture of your business.

• Automate business functions. Whether you want to support staff in managing day-to-day tasks or take care of your own, you may find ways to integrate business automation apps and tools with your Square account to automate some of your more mundane or everyday tasks. Retailers surveyed in the Square Future of Retail 2023 report invested in order tracking, customer loyalty programs, invoicing, and inventory management to minimize staff members’ hands-on time with tasks they would otherwise be executing. Join the 93% of businesses using or planning to use automation for the benefit of their staff.

• Consider hiring a professional. From a tax accountant or CPA to a financial advisor, a professional with expertise in their field can help you manage your taxes and finances and also offer advice around possible opportunities to optimize your business finances.

• Open a business bank account. Having a business bank account to separate your personal and business finances will not only help you build a business credit score and business credit, but it will also help you more easily see your accounts receivables and payables.

All changes to fiscal policies, such as rate hikes, are made in an attempt to impact the broader macroeconomic trends of a country, but it’s small businesses and individuals that feel the brunt of these changes most. Keeping an eye on inflation can help you better forecast the cost of goods and services for your business, and in turn better manage your cash flow.