What is Inflation?
So, What is inflation? Before beginning to understand how inflation affects a business, it’s essential to understand what inflation means.
Investopedia defines inflation as: “Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods”.
In simpler terms, inflation is an economic term describing the phenomenon when the prices of products, services, wages, or rent increase, affecting all other products and services.
In turn, this decreases the value of a currency and makes it harder for people to buy products and services.
Investopedia helps explain this phenomenon, “As a currency loses value, prices rise, and it buys fewer goods and services. This loss of purchasing power impacts the general cost of living for the common public, leading to a deceleration in economic growth. The consensus view among economists is that sustained inflation occurs when a nation’s money supply growth outpaces economic growth”.
5 Common Effects of Inflation on a Business
- Decreases Purchasing Power
The main effect of inflation is decreasing purchasing power due to the rise in prices across the economic board. For example, years ago, a candy bar was only 10 cents, now it’s almost $2.
2. Causes a Never-Ending Circle of Inflation
As people and businesses continue to spend money to solve their issues stemming from inflation, the economy can find itself overfilled with cash that essentially deprecates the currency. In other words, the new influx of money outweighs the demand, and the money’s value falls faster than before.
3. Raises the Cost of Borrowing Money
Signature Analytics explains the effect of inflation on the cost of borrowing stating, “the cost and availability of loans can cause major problems down the road. This may not be an issue today, but it could be a bigger issue in the future”.
4. Encourages Spending and Investing Money
Because inflation at its core reduces the value of money, it encourages people and businesses to spend their money now, rather than later when the money has lost more value.
5. Reduces Unemployment Rates
Because wages are considered economically ‘sticky’, they very slowly respond to economic shifts. This means that once inflation reaches a specific rate, companies can hire more employees because their payroll costs decrease. However, it is essential to note that this phenomenon can also work in reverse.
Giovambattista Scuticchio Foderaro of Forbes summarizes the connection between the expected effects of inflation stating, “…the economy is experiencing inflation, with a steady increase in goods and services pricing over time. It devalues units of currency (like the USD and EURO), resulting in consequences like a higher cost of living”.
5 Ways to Survive Periods of Inflation
- Look at wealthy investors, and follow their advice.
The wealthy are wealthy for a reason. They have experienced years of rising and falling inflation levels and offer valuable advice to fellow investors and business owners. Try reading interviews with investors and see if any of their suggestions can be applied to your business.
2. Analyze and rethink your pricing strategy
Camino Financial suggests applying a loss leader strategy, “This will lead people to your doorstep and, while they’re buying the start product, they’ll also buy other stuff that might be a bit more expensive”.
3. Focus on essential expenses only and cut back on the non-essential expenses.
This suggestion is relatively self-explanatory. During times of inflation, it is crucial that a business cuts back on non-essential expenses and generates ways to economize its costs.
4. Generate new ways to increase sales
Forbes suggests focusing marketing efforts on existing customers rather than trying to attract new ones because new customers cost about five times more than retaining current ones.
4. Plan ahead!
Inflation is unavoidable, and being prepared can make all the difference! Don’t wait until your company is struggling to review your finances and profit margins. Plan and begin preparing now.
More Definitions of Inflation
- Federal Reserve: Inflation is the increase in the prices of goods and services over time.
- Signature Analytics: Inflation is a period when the cost of goods and services shot up. Inflation often begins with a shortage of services or products, leading to businesses increasing their prices and overall product costs. This upward price adjustment triggers a cycle of rising costs, making it harder for businesses to reach their margins and profitability over time.
- Tutor2u: Inflation is a sustained increase in the average price level of an economy. The rate of inflation is measured by the annual percentage change in the level of prices. In the UK, this is most commonly measured by the consumer price index.
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