The Insidious Tax: Inflation and Your Business

By Tom Cramer

Retention. Quality Control. Unique Positioning. There are certain words and concepts that must be part of the vocabulary and understanding of any SME executive. Some of these reflect constant concerns and priorities. Other business basics are constant but are also part of the business cycle that creates periodic, cyclical opportunities for crisis management.

The Insidious Nature of Inflation

The impact and role of inflation are factors that must always be included in planning and occasionally call for intense management focus. On June 10, 2022, the Fed reported a level of inflation unknown to this generation of business owners and operators. Hitting 8.6 percent, the rate reflected a level not seen since 1981.

While the government targets a constant rate of 2 percent annual inflation, it is tasked with using monetary and fiscal policies to avoid anything close to the corrosive effects of any rates persistently above 4 percent. Thus, the level announced has economists, politicians, and businesspeople scrambling to evaluate its impact. All are also asking:

• What is the best response to this record-high rate?
• What are the best courses of action called for to respond to this level?
• How long will the rate stay at this level?
• How high will the inflation rate reach before it levels off and returns to “normal?”

These are timely questions because the fundamental definition of inflation addresses its core damage: A decline in purchasing power accompanied by a rise in prices of goods and services. Even the targeted Fed rate of 2 percent is a factor that must be included in all long-term business planning.

The cumulative impact of even modest inflation over 20 years is a factor that must be included in long-term projections to assure realistic results. For example, if you were forecasting an annual cost of $10,000 for a certain item in the year 2000, the same item would cost more than $15,000 in 2020 based on the cumulative inflation of 50.3 percent experienced during that period.

Inflation as a Business Factor

It is difficult to forecast the rate of inflation for the remainder of 2022, but there is a better than even chance it will increase and persist for an extended period. However, whether you are reading this during the crisis or with the benefit of future hindsight, some constants about inflation are worth understanding.

First is the “good” side of inflation. As with most situations, not all aspects of inflation are unequivocally negative. Depending on your situation, inflation may:

• Lower the effective costs of any long-term fixed-cost debt on your books
• Present a short-term jump in inventory and raw materials values
• Increase in the value of some hard assets and real estate

However, these potential benefits are offset by the potential for ongoing shortages in raw materials, pressure on profit margins from costs of raw materials and components, and more expensive costs for variable and new debt.

A simplistic view of inflation by the less than knowledgeable is that you can simply raise prices to cover the added costs of doing business. However, basic economic realities show that there are limits to price increases before demand falls off and the spending habits of businesses and consumers are distorted.

Responding to the Challenge

It is not simply “positive thinking” to reflect on the fact that rampant inflation is another class of challenge that provides the potential for a competitive advantage. Achieving that advantage requires a proactive response that includes:

• Reevaluate your Product-Service Mix. Consider focusing on higher-margin products that can absorb higher costs while remaining profitable.
• Update your Pricing Strategy. Evaluate your ability to increase or maintain prices relative to your competition based on your supplier status, inventory, and other pricing factors
• Conduct a strategic reassessment of your capital structure. Should you address adding debt now to avoid crippling levels in the future, or cut back on certain expenses and capital projects to conserve cash and minimize the use of debt?

Inflation is a constant issue, and it is a periodic pressure point. Take time to evaluate what leaders in your market niche are saying and doing to evaluate the specifics for your business. Track the national trend to ratchet up your response if the ongoing news raises new concerns.

We will continue to provide periodic insights on this and related items. We encourage you to address your current priorities to include a proactive and aggressive response to the issue of inflation for your specific situation.