You will doubtless be familiar with the term inflation by now, having seen the UK’s inflation rates latest figures for CPI at 10.7% in November, down from 11.1% in October (correct as of Dec 2022). It has been the topic of conversation across all major news outlets for a number of months. Whilst there’s an adjustment period for every business trying to create or meet demand and make critical business decisions in the midst of great change, there can be some opportunity.
What is Inflation?
Inflation is the increase in the price of something over time. For example, if a tin of beans costs £1 but a year later they’re £1.05, then annual tinned beans inflation is 5%. To come up with an inflation figure, the Office for National Statistics (ONS) keeps track of the prices of hundreds of everyday items in an imaginary “basket of goods”.
Inflation is one of the most important macroeconomic elements because it directly influences the prices of goods and services in an economy. When prices rise, businesses must grapple with increased costs of production, which can negatively impact their bottom line and can also mean decreased demand for goods and services, as consumers have less purchasing power.
Effects of Inflation on Businesses
Positive effects
- Industry-wide price rises enable revenues to grow
- Growing revenues + constant gross margin = higher gross profit
- Makes using debt as a source of finance cheaper in real terms
Negative effects
- If costs are rising due to inflation, a business may not be able to pass them onto customers (PED)
- Inflation can disrupt business planning and lead to lower investment
- Rising inflation is associated with higher interest rates – this reduces economic growth and can lead to a recession
What Businesses Should Consider When Tackling Inflation
Look at your prices. This is a great opportunity to look at breakeven numbers and assess whether price increases on your products or services could lead to better profit margins. As with any change in pricing, proceed with caution as you don’t want to rock the boat too much with customers.
Look at your costs. In the same vein, it’s also a good opportunity to take a look at your costs to interrogate whether they can be reduced. Can you become more efficient and innovative in your production methods?
Maintain revenue. If you don’t already, look at how you manage cash flow. Do you have a high number of aged debtors? Make sure that you run a tight ship when it comes to invoicing and receiving payment, and be especially mindful and clear on this when it comes to taking on new customers too. Ensure you are transparent from the beginning about what is expected when it comes to making payment.