6 Strategies for Navigating Inflation
Want to see proof of inflation? Take a look at your morning coffee.
Today, your average small cup of black coffee costs about $1.59. Ten years ago, that very same cup would cost $1.25. Jump back to 1970, and it would go for a quarter.
Inflation – the process by which the purchasing power (or real value) of a given currency declines over time – is nothing new. As long as there was currency, there was inflation.
However, many economists believe that we’re heading into an extended period of relatively high inflation, which can mean big changes across the economy.
Here’s what you need to know about high inflation and how your business can navigate it.
Is inflation good or bad?
Answering that question is tougher than you might think. While the i-word has been politicized and given a negative connotation, the reality is that some inflation is part of a healthy economy.
While rapid inflation can shock the system – as it did in the U.S. in the 1970s, when oil speculation caused the price of goods to skyrocket – deflation, or the “strengthening” of a currency’s purchasing power, can be just as bad.
Deflation can lead to stagnation, or a lack of investment, which can lead to unemployment and a shrinking economy. A healthy economy will see some inflation over time; a reasonable amount of inflation will push businesses and individuals to spend their money now, rather than holding onto it, which stimulates the economy.
However, inflation that is too fast or is paired with certain other factors, like already-slow economic growth or high unemployment, can, as we mentioned, cause the value of a currency to plummet, which means that the money you have in your bank account loses value, goods cost more, employers are pressured to raise wages—and on and on.
Like it or not, inflation is here.
Regardless of whether inflation is “good” or “bad,” it looks like we are entering an extended period of high inflation.
The most recent Consumer Price Index report, a metric that illustrates the purchasing power of the U.S. dollar based on the price of certain goods, shows that over the last 12 months, the all items index increased 7%. Meanwhile, the U.S. Federal Reserve has said to expect higher inflation in the near-term. (According to the Fed, this is part of the economy returning to normal following the pandemic, and it should give way to healthy price growth over the long run.)
If you own a business, you’re probably already dealing with enough problems as is—from increased commodity prices to supply constraints and labor shortages. If that’s the case, the last thing you want to hear is some doomsayer telling you to expect yet another problem. Totally fair.
However, if the Fed and other experts are right, and we are entering an extended inflationary period, you can make the next few months or years significantly better for your business by preparing now.
And, fortunately, most of the things that we recommend doing to protect your business from inflation will also help you manage your business’ other challenges. These are ideas you should consider anyway, whether or not inflation is here to stay.
How to prepare your business
Let’s talk about what you can do to prepare your business for inflation.
If we look back at the last time the U.S. experienced high inflation – the aftermath of the 2008 financial crisis – we can see that the companies that fared the best all had a few things in common.
For one, they kept an eye on the Producer Price Index (PPI), a metric that’s similar to the Consumer Price Index, except it measures the costs associated with being a producer. As the PPI rose, these businesses increased their prices to match rates of inflation, which ensured that they were continuing to receive roughly the same real monetary value – not just the same dollar amount – for their goods and services as before.
Matching prices in accordance with the PPI is always a good practice. But during the high periods of inflation following 2008, the businesses that performed the best took five additional steps. Here are the steps and what we can learn from them:
- They cut costs across the board. An analysis of 5,700 companies showed that those that focused on cutting costs to increase productivity the most during periods of high inflation achieved significantly higher shareholder returns. (The median was a whopping 27% more.)Where might your business cut costs? Start by talking to your people and taking a closer look (or, better yet, having your accountant take a closer look) at your financial reports. Then, compare what you find to other, similar businesses and identify areas of improvement.
- They focused on profitability. Using that same comparative technique we just mentioned – it’s called ‘benchmarking’ – identify the most and least profitable areas of your business. Then, explore how you can focus more of your time and resources on the most profitable areas. Some of this may sound obvious, but you’d be surprised what business owners and other decision-makers learn when they sit down and take a closer look at their company.
- They improved their cashflow management. Like everything else on this list, improving your cashflow management is something you can and should do at any time, regardless of inflation rates. However, keeping a close watch of how money moves through your business, making projections, and pinpointing potential vulnerabilities is especially important during times of great economic change and uncertainty.
- They leveraged technology. Invest in tech that cuts costs, automates production, allows you to perform new services, and otherwise enhances your profitability. This can shield your business from rising material costs associated with inflation, as well as other chronic issues, like labor shortages.Just keep in mind, as inflation reduces the dollar’s purchasing power, the price of new technology will continue to rise. If you’re looking to invest, you may want to invest now.
- They managed production costs. In addition to investing in tech that improves your productivity, we recommend either securing longer-term price commitments from your suppliers – so that you won’t be stuck with price increases due to inflation – and/or structuring price escalators in your customer contracts.
Ride the wave
Whether the current period of high inflation is short-lived or here to stay, the strategies listed above can have a positive impact on your business and help you deal with challenges like rising material costs, supply-chain issues and labor shortages. And, if the experts are right and we do experience a high tide of inflation, you’ll be poised to ride the wave.
Want to talk about inflation, or anything else related to your business’ finances? Dugan & Lopatka is a full-service accounting firm that provides a range of solutions, from business advisory to cashflow management. For nearly 50 years, we’ve partnered with businesses to help them navigate change and achieve their goals. We’d love to help you achieve yours. Get in touch.