our personal finances may not be the only ones feeling the pinch this year: inflation’s effects can also hit your business.
Simply put, inflation occurs when the purchasing power of a currency decreases over time, and prices rise in response. This movement is the inverse of deflation, where the purchasing power of a currency increases and costs can drop. Inflation has increased significantly since the beginning of the year, peaking in May. The Fed (Federal Reserve System) predicts that there will be a high inflation rate of 5.5% through the last quarter of 2022. Economists are predicting higher inflation rates as well.
You're not alone if you’re worried about the increased costs and how they’ll influence your business operations. While we’re not yet in a state of hyperinflation, the aftermath of the pandemic has left many small business owners wondering how to protect their businesses from rising inflation.
While you can’t control volatility in the market or the cost of goods and other business expenses, you can take steps to ensure you use your business funds wisely and stretch them further. Here are some best practices to adjust your business budget for inflation.
Review Your Business Budget
Since we’re living in an inflationary environment, it’s a smart idea to review your business budget to see where you stand. That way, you can ensure you’re remaining profitable and have enough of a buffer to see you through lean times. Plus, when costs go up, you avoid feeling the stress or pressure to take out additional loans to keep running daily operations.
Look at what you have allocated for each spending or expense category, then track how much you’ve actually spent. Browse your spending reports to review your expenditures under each category and whether you need to make changes.
Identify areas where you can cut down on spending that have little or no impact on your business's long- and short-term health or growth. Ask yourself, is it possible to cut back on expenses, or will you need to find a way to earn more in your business?
Remember that it’s also important to review your budget regularly, especially as you see costs rising consistently. Even if you do not see increases so far, assume your expenses will go up and adjust your forecast as necessary.
The more proactive you can be about financial planning for your business, the less strain you’ll feel later. Depending on the size of your business and budget, it can even be worth bringing on a financial advisor to help you with some of this work.
Eliminate or Cut Back on Expenses
One of the best ways to protect your business from inflation is to cut back on expenses. When reviewing your budget, you’ll want to scrutinize whether certain expenses make sense and whether you’re spending the right amount on them.
In other words, are you getting a return on your investment with your spending?
Suppose you run a home goods store and find that packaging prices have gone up. If you want to cut costs, you can shop around other vendors for better prices or negotiate with your current one to see if they’ll offer you a discount on large bulk orders (assuming that makes sense for your business).
Or, to save costs, you can stick with the same vendor and cut back on packaging — like plain color wrapping paper instead of the specialty ones.
If you find that some of your spending hasn’t helped your business, you can consider eliminating those expenses or putting a temporary hold on them. For instance, you may decide to stop buying tea for your staff since most drink coffee. Take a close look at any recurring software expenses as well. Depending on the software and its usefulness, you may find that you can switch to a lower tier or cut out the subscription without any negative impact on your business.
Wherever you decide to cut back on expenses, don’t lessen the quality service you provide to your customers. Otherwise, you could find your business will suffer long term.
Reduce Interest Rates on Debts
You can’t pause or avoid paying back your business loans. However, you may be able to reduce the overall amount you pay.
Depending on your loan type, shop around with lenders to see if you can refinance your loans to a lower interest rate. Doing so can lower your monthly payments and save thousands of dollars in interest in the long term.
Remember that refinancing a loan may not be the best move for every business. You’ll likely need a good business credit score to qualify for the best rates. Don’t forget to watch out for prepayment penalties with your current loan and refinancing fees, as these can eat into your overall cost of borrowing.
If possible, see whether your business is eligible for SBA refinancing. Compared to private lenders, the Small Business Administration offers some of the best terms and rates. You may be able to refinance loans from other lenders as long as you meet some of their criteria, including proving that your business will benefit from refinancing, that your current lender isn’t at risk for loss, and that current debt terms are considered unreasonable.
Make a Plan For Income Growth
There’s only so much you can do to lower or eliminate spending. Planning to increase your business income should be an essential item on your list.
Of course, planning for growth depends entirely on your business and industry, but you can start with different tactics to increase your sales. For instance, are there ways you can test out different marketing strategies to bring in more customers? Or finally launch the new product line customers have been asking about for months?
Another solution is to raise prices on your existing goods and services. You can offset your pricing for inflation by looking at the Bureau of Labor Statistics’ Consumer Price Index (CPI) percentage increase. This tool will tell you the average price increase in consumer goods over a period of time, or the inflation rate. That way, you can justify the increase in your prices if you raise them along the same lines as the CPI increase.
You can also raise your prices by looking at your business budget and tracking your net and gross profit margin.
Here’s how you do it:
- Compare your profit margins from the previous year to now and determine the percentage change.
- Look at your business budget for this year and take the percentage increase from last year to this one to give you an updated projection of your profits.
- Look at any increases in salaries for you and your employees and consider them.
- Using the above percentage increase, calculate how much you’ll need to increase your revenue to reach your goal revenue and net profit margin.
Pricing out existing customers by raising the cost of your products or services too quickly is a valid concern. If you think that your customers will be upset at higher prices, notifying them in advance can help. On the other hand, thoughtfully planned, incremental price increases can also help your existing customers to adjust over a period of time.
Inflation is a fact of life, and even the federal reserve can’t prevent it — the question is how much inflation will rise each year. To ensure your business survives (and thrives!) in the long run, take a step back to evaluate your budget, forecasts, and income. Then, adjust your plan to protect your business against uncertain economic conditions.
This page is for informational purposes only and is not intended to be relied upon as legal, financial, or accounting advice. Please consult your own professional if you have any questions.