How Inflation Impacts Small Businesses
The Consumer Price Index (CPI) measures the changing prices for goods and services. Inflation often starts with a shortage of products or services, forcing businesses to increase their prices. As prices rise, they trigger increasing costs, making it difficult for businesses remain profitable.
Inflation has a significant effect on small businesses because they are less able than large ones to absorb price increases. These effects include higher prices for raw materials and transportation, which can lead to a drop in profit margins and an increase in product prices, making it harder for small businesses to compete with larger ones.
With inflation, purchasing power is reduced significantly, causing businesses’ profits to decrease as they sell fewer products. Reduced profits result in a decreased ability to invest in businesses. Most small businesses, especially those with fewer than 500 employees, are highly affected and experience a financial risk since most of their capital is the owners’ savings. The inflation rate has been rising since 2008, but it is still below the target rate set by central banks worldwide.
The American economy has suffered a blow since the pandemic started in 2020, exhibited by increasing inflation characterized by rising costs of goods and shortages in the supply chain. Small businesses require reliable inflation data to understand the economic challenges and plan to overcome them.
Data from the Bureau of Labor Statistics indicates that inflation accelerated the most from the third month of 2021 through the ninth. The data further indicates that inflation in 2021 was double that of 2020. In 2021, inflation rose steadily until April, when it shot from 2.6% to 5.4%. According to government data, this was the highest inflation rate recorded since 2008.
The year 2021 saw many small businesses increase the cost of products over 20% due to the skyrocketing business expenses. A study conducted on small businesses in America indicated that 92% of these enterprises saw an increased cost of services and suppliers they desperately needed to run the business. In 2022, 71% of small businesses noted a 20% increase in the cost of services and suppliers. Small businesses suffered severely from inflation during the pandemic.
Here are some of the ways inflation has impacted small businesses.
1. Increased Costs
Inflation is a natural phenomenon that occurs when the demand for goods and services increases faster than the supply. It might be suitable for some people, but it can be terrible for small businesses.
They have to spend more money to stay afloat in an inflationary economy. This causes them to either increase prices or cut down their spending on other business areas. The best way for small businesses to combat inflation is by looking at ways to lower their production cost and increase their profit margins.
2. Reduced Profitability and Business Value
Inflation has caused a decrease in business value and profitability, as companies are forced to increase prices to maintain their market share. This is due to factors, including the dramatic increase in the cost of living, shifts in people’s discretionary income, and specific supply chain changes that have made it harder for businesses to hold on to their market share.
3. Decreased Purchasing Power
With the rising cost of living, the value of wages is declining. This decline is not just about the increasing price of groceries and rent; it’s also about the cost of education, health care, and childcare. We should think about making our wages more valuable to keep up with inflation by reducing expenses and saving money. It’s essential to think about what we want for ourselves and our families to ensure that we are not losing out on opportunities because we cannot afford them.
4. Supply Chain Shortages
Inflation is one of the most important economic indicators. As costs rise, businesses need to make more money to stay afloat. With inflation rates rising in recent years, it has been more challenging for businesses to produce goods at a reasonable price. This is causing supply chain shortages across many industries including the automotive.
The availability of things you sell may be impacted by inflation. It may, for example, lengthen wait times, reduce supplies, and generate import complications. These factors may wreak havoc on your supply chain, making it more difficult to meet client demands.
You risk disappointing your clients if you rely on a supplier and that provider fails to meet your demands. You won’t have a backup plan if that supplier’s costs skyrocket.
Shortage in the supply chain means that the business cannot acquire raw materials, and consumers experience shortages in the market.
Most American manufacturing industries in 2021 did not receive their raw materials in good time because of the global supply chain crises. Shipments from different parts of the world, including China, could not reach their destinations because of the heightened threat of coronavirus infections. Once the supply chain is disrupted, some small businesses are forced to close down altogether since they lack the ability to produce and distribute products.
5. Increased Debt on Loans
You may consider getting a loan to assist you in dealing with inflationary pressures. When loans are offered at an interest rate that changes with inflation rates, it can significantly impact how much interest will accumulate every month. As a result, you’ll pay more interest on your loans, bringing your total debt to a higher level.
How Can Small Businesses Counter Inflation?
Dealing with inevitable inflationary pressure in small businesses is an art that will see businesses rise in 2022 as the COVID-19 infection rate subsides. Some of the measures businesses should take include the following.
1. Optimize Pricing
It is essential to understand the inflation rate and work as per the data provided by the government and the most outstanding financial organizations. Furthermore, businesses are expected to develop an optimized pricing strategy that will ensure customers do not leave the business for competitors who make different pricing decisions. Knee-jerk price hikes will cause instability, leading to low business and significant competition.
During inflation, small businesses are advised to use marketing to create value and find ways to improve customer service and experience. Such strategies will directly impact the pricing power of the business and influence the customers to pay for products and services regardless of the price.
Apply a loss-leader strategy where you lower the price of one star product to cause more consumers to visit your store. While purchasing the star product, they will also find other items to purchase.
2. Pay Attention to Your Expenses
During inflation, small businesses should focus on their expenses and ensure they are low. Entrepreneurs and business leaders should take the opportunity to cut unnecessary expenses that won’t hinder the production process. If you save a dollar or two over and over again, it will strengthen your cash flow. Small businesses should strive to improve processes while spending less and winning more. Lean management strategy is all about ensuring waste is at its lowest and economizing in the production process wherever possible.
When the pandemic hit, nearly half of small businesses were forced to reduce inventory by nearly half to overcome the impending burden of inflation. Management of small businesses was expected to be at its best during this time, with most companies procuring management systems that would help them track expenses. Others have hired online accountants to develop ways for the company to save money. Various businesses have taken other measures to save on their expenses, including moving to cheaper workplaces.
3. Evaluate Risks to Your Supply Chain
The supply chains of modern businesses are complex and excessively long. The supply chain process is riddled with numerous risks as raw materials move through the manufacturing process, and refined products are readied for the market. Leaders of small businesses can shield their establishments by protecting the supply chain.
Some of the common risks associated with the supply chain include:
• Passing materials through the just-in-time (JIT) supply chain
• Using foreign suppliers or importers
• Depending more on a single supplier
• Perishable goods that are expensive to store and transport
• Bulky, heavy, or hazardous materials
4. Plan Ahead
It is essential to review your finances carefully whenever an inflation alert is issued. Small businesses will require extra funds to pull through the inflation. Leaders should prepare for such eventualities and consider raising secure business loans beforehand. Small businesses should invest in the business when they are successful in securing funds to weather the storm. American Business Credit plays a significant role in offering loans that enable businesses to continue with operations during inflation caused by eventualities such as COVID-19.
We have shown that inflation makes it difficult for small businesses to survive because of challenges such as declining profits and rising operational costs. Small businesses need to prepare for inflation and take the necessary measures outlined in this article. A survey conducted in 2021 by Business.org indicated that 89% of small businesses were adversely affected by the pandemic and had to increase their prices.