Business Advice, Finance

How Does Inflation Affect Businesses and How Should You React?

Business Advice | 30 May 2023 | 1 year ago

There is a lot of information about inflation, but knowing what causes inflation and how inflation affects businesses can be confusing, especially if it’s not something that you have had to navigate before. Even if you know a little bit about how inflation affects you on a personal level – the cost of goods and services rise, for example – it’s not always clear how this translates to the world of business. In this blog, we have taken a look at what inflation is, what causes inflation and how inflation could impact your business.

What is Inflation?

The first thing to know about inflation, is that inflation refers to the sustained increase in the general price level of goods and services in an economy, and this happens over a period of time. It essentially means that the purchasing power of money decreases as prices rise, meaning that everything becomes more expensive.

There are positives and negatives to inflation, and it affects the economy in a variety of ways. A small amount of inflation can be a sign of a growing economy, as it suggests increased demand and more economic activity. Simply, it shows that people have more money and they are spending it. It can also encourage investments, as people are encouraged to buy goods before the prices rise even further. However, a lot of inflation or persistent inflation is rarely a good sign. If people can’t keep up with the rising costs, standard of living becomes affected and businesses struggle to plan for the future. With prices rising at an alarming speed, businesses can struggle to stay afloat.

What Causes Inflation?

There are a range of things that can cause inflation, and sometimes more than one can come into play. One of the main causes of inflation is the increase in demand. When the demand for goods and services goes beyond the available supply, it can lead to inflation, as everyone is trying to buy the same goods and there isn’t enough to go around. Increased consumer spending or investment can drive up demand and put upward pressure on prices. Another cause of inflation is the increase in production costs. When the cost of production rises – which can be due wages going up, the increased cost of materials or rising energy costs – businesses need to raise the price of goods and services to ensure that they still make a profit. If the price of goods and services aren’t raised, businesses start to lose out.

Sometimes, inflation happens before prices rise. This can happen if businesses are expecting prices to rise in the future and they adjust their behaviour with this in mind. For example, if staff are asking for pay rises, a business might increase the prices of products to ensure they can meet these demands. There’s also the possibility that external factors and circumstances around the world will cause inflation, such as changing exchange rates or rising costs of importing and exporting goods.

How Does Inflation Affect Businesses?

There is no denying that inflation has an impact on everyone, but how does inflation affect businesses? One of the biggest things that a business has to navigate during a time of inflation is increased costs. Inflation often leads to an increase in the cost of production inputs, such as raw materials, energy and wages. Businesses may face higher expenses when getting these resources, which can impact profit margins. If businesses are unable to pass on these increased costs to consumers through higher prices, their profitability may be affected. Businesses may also have to deal with increased interest rates during inflation. This is because interest rates often increase in response to inflation, making it more expensive for businesses to borrow funds for investment or expansion.

Inflation can influence consumer behaviour and purchasing power. As prices rise, consumers may adjust their spending patterns, prioritising essential goods and reducing luxury spending. Simply, consumers can’t afford to treat themselves if they are already struggling to keep up with rising costs of day to day life. Businesses that rely on non-essential or luxury products may experience a decline in demand, especially those with expensive products available. There is a lot of uncertainty during inflation, which makes long term planning and forecasting more challenging.

How Should My Business React?

  • Increase Prices – To counterbalance the effects of inflation, you could consider increasing the price of the goods and services you provide. Though this will end up costing your customers more, it will help you to keep up with the rising prices of wages, materials and overheads. By increasing your prices, you can spend more on rising costs, without impacting your profitability.
 

  • Review Your Outgoings – As a business, there is a high chance that your outgoings could be reduced, which is why reviewing them is key. If you are finding the rising costs of inflation hard to navigate, review your outgoings and see if your spending can be cut. You might be able to find a cheaper supplier, a more cost effective way of shipping or ways to save money on your software subscriptions.
 

  • Update Forecasts – By updating forecasts to incorporate inflation, you can gain a better understanding of the potential challenges and opportunities that your business could face in the financial climate. This allows you to make informed decisions, adapt your strategies and take appropriate measures to reduce the risks associated with inflation. Not only will this help you to manage your finances, but it will also help you to maintain your competitive edge.
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