In the UK, the Bank of England is tasked with keeping inflation at exactly 2%. It is, however, permitted a 1% margin of error in both directions. That means, inflation in the UK should never be lower than 1% or higher than 3%. Recently, however, inflation has been consistently above target. At present, it looks set to stay that way.
What is inflation?
Inflation indexes such as the RPI and the CPI measure how expensive goods and services are over a set period. Inflation is the rate of this increase in prices over a set duration of time, usually a year. This is typically referenced as a broad measurement, for example it might reflect the cost of living in a country. It can, however, 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 one pound sterling decreases as the price of goods and services increases. This makes it increasingly expensive for consumers to purchase goods and services.
How might inflation affect small businesses?
The impact of inflation on businesses largely depends on whether or not incomes remain proportional. If they do, businesses can simply increase their prices to reflect their increased costs. If, however, they don’t, businesses have to find ways to do more with less, or risk going out of business.
Here are four ways that inflation could impact your business operations and, in particular, your cash flow.
Even if businesses do manage to keep their prices the same (or lower them), consumers may still buy less. If prices are rising overall, consumers are more likely to be under pressure to cut back on discretionary spending. They may even be forced to cut back on essentials.
Narrower profit margins
Profit margins, impacted by raised costs, could narrow. For businesses, this may mean making changes to better manage and forecast profit margins.
Reduced access to credit
Suppliers may become less willing to allow businesses to have credit at all (especially SMEs). If they do allow it, they may restrict the terms.
Enforced changes to inventory
Businesses may not be able to afford to maintain a wide range of inventory. Even if they can, suppliers may not be able to offer the same items due to issues with their own operations. In fact, suppliers themselves may go out of business.
While this may seem bleak, even for SMEs on tight budgets, the situation is far from unsalvageable. It just means that businesses have to operate even more astutely.
For example, instead of increasing prices, businesses could try reviewing their pricing models to improve their profit margins. What this means in practice will, of course, depend on the business model. Some common strategies include encouraging customers onto subscription pricing, offering bundles of items at a discount to buying them individually and offering a discount (or other benefit) for early payment of invoices.
It will also be essential for businesses to manage their cash flow effectively. For practical purposes, this is likely to mean using cash flow management tools as much as possible. You should, however, still be prepared to pay for human expertise when needed.
When to use cash flow management tools
How inflation affects your business will depend on several factors, including the type of business you run, the goods and services you offer and where you are located. Nonetheless, there are some universal ways you can manage your cash flow, help forecast your business’s finances and make decisions in light of inflation.
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. Additionally, by setting aside funds in a business savings account, you can protect your business from the erosive effects of inflation and ensure you have a financial cushion to navigate through challenging economic periods.
Using expense-tracking software can help you keep your finances organised. In addition to this, look into basic business accounting tools to help you see a more holistic financial picture of your business.
Automate business functions
Whether you would like to support staff in managing day-to-day tasks or take care of your own, you may find ways to automate some business processes. Retailers surveyed in the Square Future of Retail 2022 report invested in order tracking, customer loyalty programmes, invoicing, and inventory management to minimise staff members’ hands-on time.
Get professional help
In addition to using the right tools and processes, consider hiring a professional. At a minimum, using an accountant to help you file your taxes will help to ensure that you pay what you owe and no more. An accountant can also offer you broader guidance on how to manage your business’ finances.