HOW DOES INFLATION IMPACT YOUR BUSINESS?
What Is Inflation?
Inflation is a term used to describe the change in price of a bundle of products and services over time.
Normally, it’s defined as a rate, for example, if the total price of a bundle of goods and services was $100 a year ago and now it’s $105, then the inflation in the last twelve months of those items is 5%.
How Is Inflation Determined?
Public institutions set a specific bundle of products and services and find the weighted average of price change over a timeframe to determine the nation’s inflation.
These means that while some prices of the items in the bundle could increased 20%, the overall inflation might yield lower as many other items had a lower inflation increase. For example, the price of motor fuel increased 49.6% from Oct 2020 to Oct 2021, but the overall ‘inflation’ in this same period was 6.2% – which is still a historical 30-year high.
Why Is Inflation a Concern?
Inflation concerns everybody because it makes money saved, less valuable due to the price of the products and services increasing while your money that is saved in the bank is still the same.
This means that your ‘purchasing power’ decreases and hence the value of your money is less. Your $100 dollars in the bank now buys you less goods and services.
What Causes Inflation To Increase?
There are different sets of circumstances in an economy that can drive inflation up or down, some of them are:
Low supply of raw materials: when there’s a low supply of raw materials, as is the case currently, the prices of them tend to go up. These increases are generally passed on to the consumers, resulting in higher prices.
Wages increase: As in the previous point, with wages increasing, production costs rise, which then tend to be passed on to consumers.
Increased Demand for a product/service: All else equal, a perpetuated increase or sudden spike in demand tends to pull prices up as there are more willing buyers demanding the product or service, while the supply stays the same.
Low Interest Rates: Low interest rates encourage investment and consumption. Increasing both the demand for capital goods and the demand for end products. All else equal, an increase in the aggregate demand will generate inflationary pressure explained by producers having to catch up to the higher demand from consumers (“many bucks chasing fewer goods”).
How Does Inflation Affect Businesses
Some of the ways inflation can affect your business’ operation are:
The increase in cost of raw materials can shrink your business’ profits.
If the expected inflation is high and uncertain, the purchasing power of the expected distribution of earnings (profits) from your business is lower.
Employee costs can increase as people demand higher wages to maintain their purchasing power, resulting in a reduction of profits.
The demand for your products and services can reduce due to customers not being able to meet an increase in prices.
How Can Inflation Impact Your Business´ Value
Your business value can be affected by inflation in different ways, some of them are:
Based on the prior points, the earning power of your business could decrease, hence the cash flows that it can generate to an investor would be less, driving down the value of your business.
A high inflation rate does not instantly mean that your business’ value will be affected. If inflation is expected to go back to normal levels, all else equal, the required rate of return from investors in your business can remain untouched.
However, if investors don’t trust that inflation will go back to normal levels, the uncertainty could result in investors requiring higher rates of return in order to cover themselves from possible reductions in purchasing power of their money and/or instability of the economic conditions in the country.
Inflation is a matter that concerns everybody. The repercussions from a high and/or uncertain inflation can be detrimental to the value of your money and your business.
It’s important that businesses are aware of potential impacts to plan ahead or hedge their risks to potential losses in revenue, and shrinking of margins, among others.
If you would like to know more on how your business’ value can be impacted by inflation or other economic factors, make sure to contact us.