Managing Inflation for Small Businesses
Inflation poses serious challenges to businesses worldwide. However, small businesses operating on thinner margins often experience more intense inflation effects than larger businesses and corporations. Inflation can increase raw material and production costs while decreasing profit margins.
While some businesses opt to pass these costs to their customers by increasing their prices, this strategy can be counterproductive if not implemented correctly. For instance, your customers may cut down on their spending, leading to a decrease in your revenue.
For small businesses, managing inflation requires a strategic approach that ensures business continuity without compromising operations.
What Is Inflation?
Inflation is the gradual loss of buying power, reflected in increased prices of goods and services over time. It is calculated as the average increase in the price of a basket of selected goods and services for one year.
A high inflation rate means the prices are increasing quickly. A low inflation rate means the prices are rising slowly. When prices decline exponentially instead of increasing, it results in deflation.
Understanding Inflation Effects
The main cause of inflation is an increase in the supply of money. Additional causes include shortages of critical goods and supply bottlenecks. When inflation hits the markets, money loses its purchasing power. Businesses may start charging higher prices, and workers may demand higher wages in anticipation of sustained inflation. This further reinforces factors that push the prices of goods and services up.
The average rate of inflation in the United States was 4.1% in 2023. At the basic level, you’ll see the effects of inflation in the increased price of groceries, bills or even mortgage payments. Corporate executives, entrepreneurs, founders and business managers must deal with the effects of inflation and find ways to protect margins while paying for raw materials.
Some of the major effects of inflation on small businesses include:
- Decrease in customers’ purchasing power: Inflation reduces the customer’s purchasing power, which lowers their demand for goods and services.
- Increased costs of goods and services: Inflation can increase business overhead costs like labor, raw materials, utilities and more.
- Higher interest rates: One tactic the Federal Reserve implements to manage inflation is raising interest rates, making it more expensive for businesses to access financing options.
- Challenges in planning and budgeting for the future: Price fluctuations make it challenging for business owners and managers to make accurate financial projections.
Ways for Small Businesses to Manage Inflation
Inflation is almost always inevitable, the only difference being the rate at which prices change. As a business owner or manager, you must constantly develop plans to manage inflation and implement them effectively for the best outcome.
Review Your Efficiency Strategies
One of the most effective ways to manage inflation is by improving operational efficiency. Conduct regular reviews to identify areas where you can cut costs without compromising the quality of your goods or services. For example, you can invest in efficient appliances that will still give you the same output at a lower energy cost. You can also use apps that track and boost productivity.
Some options include reducing noncritical fixed business costs and canceling unimportant subscriptions.
Invest in the Right Technology
Invest in business technologies that will help automate processes. These technologies can help your business reduce manual labor costs and increase efficiency. Some tools to consider include:
- Customer relationship management (CRM) software.
- Expense management software.
- Software for your finance team.
- Project management software.
Depending on your specific line of business, you may want to consider industry-specific tools that can help improve your team’s productivity. Businesses unlock the most value with technology when they apply it to innovate their entire business model instead of focusing on disconnected use cases.
Retain Your Employees and Customers
You might be tempted to cut operational costs by laying off employees, but this is unwise if you’re doing it solely because of inflation. Your employees possess valuable insights and skills that contribute to your business’s success. Losing them can compromise operational efficiency and innovation. You’ll incur high costs associated with severance pay, as well as recruitment and training expenses when you eventually need to hire new talent.
Instead of panicking, letting go of loyal team members and desperately searching for new customers, focus on what you have — both your existing employees and customers. Create strategies for retaining your employees, such as flexible work arrangements, wellness programs and career development opportunities. Additionally, develop products or services your customers love and provide them with better experiences.
Analyze Profits
Analyze your profit margins to understand where your business stands based on your target goals. Inflation can derail progress, and you may have to change tactics to meet business goals.
An adverse effect of inflation on small businesses is the increase in operating costs, which can crunch the profit margins. Companies must look for creative ways to boost profits during this period without affecting the quality of products, services and customer experience.
For example, you may have to diversify your supply chain to provide a buffer against inflation. Businesses that don’t rely on a single source for products or materials can mitigate the risks of price hikes from specific suppliers. When you can negotiate with multiple suppliers, you have more options and leverage. Venture beyond your neighborhood, town or city. Build strategic international partnerships.
Build up Cash Reserves
Maintaining healthy cash flows is essential for any business, especially small businesses. Managing inflation means having enough cash flow to meet business operational costs when input prices are likely to rise. If a business doesn’t have this cash to cushion against the effects of inflation, it may have to resort to urgent and expensive loans or even close down. Small businesses should anticipate situations for cash flow challenges and secure lines of credit before the cash is needed.
You can improve your cash flow by encouraging customers to pay your business faster. Consider offering discounts for customers who can pay early.
Adjust Prices Strategically
Some businesses pass production costs directly to consumers without considering factors such as the percentage increase in the price. Instead, you should increase the price thoughtfully to avoid turning away your client base. Businesses must strike the right balance between increasing their price and retaining their customers, especially when it’s necessary to pass some costs to the clients.
You may have to communicate the price increase to your customers. Be upfront about the reasons for the increase in pricing. Timely communication can help in building trust.
Partner With Marshall Jones for Reliable Accounting Services
Preparing for inflation equips you with the right tools to combat it when it comes. As a full-service accounting service provider, Marshall Jones can help you save time in managing your finances.
Our team of certified public accountants and advisors has served businesses and individuals in Atlanta for over 30 years. Our accounting services include year-end financial statement audits, compilations, reviews, tax compliance and consulting.
Let us help you save time, refocus your resources and improve your operations. Get in touch with us for more information.