What Is Inflation and How Does It Affect Small Businesses?

Small business owners say broader economic trends are having a negative impact on their business. The top three challenges they cited? Difficulty finding and retaining qualified employees, supply chain issues, and inflation.

This article is for educational purposes and does not constitute legal, financial, or tax advice. For specific advice applicable to your business, please contact a professional.

Editor’s note: on March 16, 2022 the Federal Reserve raised interest rates by 0.25% taking the federal funds rate from 0.25% to 0.50%. This marks the first time interest rates have been raised since December of 2018. The Fed also released a set of projections indicating rates could be raised again at upcoming policy meetings this year.

The inflation rate has been surging in the last two years, and with it costs to supplies and wages for business owners. Eighty-five percent of small business owners polled in a January 2022 Goldman Sachs survey say broader economic trends are having a negative impact on their business. The top three challenges they cited? Difficulty finding and retaining qualified employees, supply chain issues, and inflation. The majority (84%) of these business owners say inflationary pressures have increased since September of last year, with 76% adding that it has affected their business’s financial health negatively in the last few months.

What is inflation?

Inflation measures how expensive goods and services are over a set period of time. Inflation is the rate of this increase in prices over a set period of time, 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. 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 a 2021 Business.org survey, 89% of small business owners have increased prices since the start of the pandemic. Of those surveyed, 45% raised prices by more than 20% in 2021 and 46% are planning on reducing their inventory in 2022 to combat inflation. Here are a few ways inflation may impact your business’s cash flow:

  • Increased costs: Costs of supplies or services to run a business may increase as a consequence of inflation.
  • Raised prices: With recent labor 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 consider raising prices of 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 and forecast profit margins. 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 choose to maintain a minimum inventory, saving on costs to store those items by buying the minimum number they need. Others may instead source locally, potentially saving on costs to transport materials and supplies.

As cost of goods sold changed for Michigan-based ice cream truck and digital agency, Ice Cream Social. They focused on offering local goods as they extended their business season from summer into fall. Offering apples, a popular fall staple in the area, made the availability of the apples and cider easier to predict in a tumultuous time.

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 are located. Despite this, there are some ways you can actively manage your cash flow and help forecast your business’s finances and decisions you may need to make.

  • Tracking expenses. Using expense-tracking software can organize accounting needs for your business. In addition to this, look into basic 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 Commerce 2022 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.
  • Consider hiring a professional. From a tax accountant or CPA to a financial advisor, a professional with expertise in their field can not only help you manage your taxes and finances, but 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.
Learn more about Square Banking.

Sell, save, spend, and borrow as fast as you need to.

In the National Federation of Independent Business’s (NFIB) December 2021 Jobs Report, 36% of business owners reported that supply chain disruptions had a significant impact on their business, and another 32% reported a moderate impact. Among those reporting lower profits, 32% cited a rise of cost in materials as the cause, followed by weaker sales and labor cost.

Although fiscal policy changes are made to impact broader macroeconomic trends, these changes do ultimately affect small businesses. The Federal Reserve, in times of inflation, may consider raising interest rates to combat it. 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.