However, Effects of Rising Prices can be Managed
It is generally accepted that moderate inflation is good for business. For one thing, inflation usually means the economy is growing, leading to higher demand. Inflation also encourages consumers to buy now rather than later. It can also make moderate price rises easier to sell to customers.
Inflation of around 2% is generally considered to be acceptable. Anything above 2% may impact the economy negatively. So, what can you expect when inflation persists at a high rate? Naturally, costs will rise, putting pressure on gross and net profits. However, the impact of rising prices will vary for different cost types. And there are other effects of inflation to consider, too. Here are ten ways persistently high inflation will impact a business.
1. Higher Raw Materials Cost
The rising cost of raw materials will erode gross margins if sales prices are not increased. However, the erosion in gross margins may not be immediately apparent because existing stock at lower prices is used first. However, that inventory will, of course, require replenishing. So, it is best to use the current or predicted cost of raw materials for any pricing decisions when there is high inflation.
Inflation rates vary by region and country. Consequently, if a company imports raw materials, price rises for materials may differ from domestic products. In some cases, it may be possible for a business to source materials from regions where inflation is lower.
2. Higher Distribution Costs
When rising energy prices cause inflation, distribution costs are likely to be the first that increase. The rise in distribution costs will impact on the cost of shipments to customers and from suppliers. Service providers will likely be the only businesses to escape this impact of inflation. However, service companies will see an increase in the cost of travel.
3. Higher Overheads
You can expect all overhead costs to rise during high inflation. The rising prices will further erode net profit already impacted by higher raw material and distribution costs. It will take longer for inflation to increase the cost of long-term fixed-price contracts, such as property rent, maintenance contracts, and SaaS (software as a service) contracts. However, if inflation remains high for an extended period, you could see significant annual increases in costs of this type.
4. Pressure to Raise Salaries
Employees will be feeling the impact of inflation, too. Consequently, there will be pressure to increase wages and salaries. Businesses that do not increase pay in line with inflation risk losing workers. A high employee turnover means higher recruitment and training costs and a drop in productivity. Therefore, it is usually best to increase wages and salaries to retain employees.
5. Decreasing Demand in Some Sectors
Inflation erodes the spending power of businesses and consumers alike. Consequently, B2B (business-to-business) and B2C (business-to-consumer) companies may experience a drop in demand. The degree of the reduction will depend on the sector. Demand for luxury and non-essential products will tail off faster than luxury goods. However, demand for low-cost alternatives could rise. For example, suppliers of luxury long-haul vacations might see a sharp drop in sales. In contrast, domestic resorts and attractions might see increased sales.
6. Higher Borrowing Costs
As inflation gets higher, so will interest rates. Consequently, servicing existing debts will become more expensive. You may also find it more challenging to obtain new financing. The good news, however, is that inflation devalues money. As a result, you will be repaying the capital element of loans at face value with money worth less than when you took out the loan.
7. Increase in Overdue AR Accounts
As prices increase, customers will have less money to pay their bills. So, businesses will likely see a rise in overdue accounts receivable (AR) as consumers and companies try to manage their limited available cash. The knock-on effects of this will be higher collection costs, a squeeze on cash flow, and possibly the need for increased borrowing.
8. Higher Risk of Bad Debts
As inflation bites, some companies will be forced into administration. Consequently, there will be a higher bad-debt risk for B2B businesses. Some consumers will also struggle to pay their bills, so low-value consumer debts not worth pursuing will need writing off. Therefore, it is advisable to step up collection efforts during high inflation and tighten the credit-checking procedures for new accounts.
9. Pressure to Raise Prices
To a certain degree, businesses can counter the effects of inflation by cutting unnecessary expenditure and improving efficiency. Ultimately, however, persistent inflation will necessitate increases in sales prices. Consumers and companies will be fully aware that prices are rising. And competitors will be in the same boat. So, it is generally best to adjust prices in line with the inflation rate and be honest about the reason for the increase.
10. Growth Hampered
A period of high inflation is generally not the best time for most businesses to expand. There will be uncertainty about future demand and costs. And it would be advisable to retain cash reserves as a cushion against rising prices and possible bad debts. As mentioned above, the cost of borrowing will also be high. So, it’s not the best time to increase borrowing. In most sectors, a period of high inflation is a time to dig in, weather the storm, and, work to become a leaner and stronger company.
The Bottom Line
High inflation certainly presents challenges to businesses. But the effects of rising prices can be managed. If costs are controlled, cutbacks are made when needed, and sales price increases are implemented in a timely fashion, margins can be maintained. Expansion plans may have to be put on hold. Nevertheless, a business in good shape will cope with inflation with sound financial management.
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