Inflationary pressures have been steadily increasing over the past year with prices being driven by rising global demand during the COVID pandemic and supply chain problems. There is no avoiding inflation when it happens, and it’s happening now, not only at home but globally.
With international travel and logistics also unlikely to return to pre-COVID levels for some time, demand will continue to exceed supply, meaning inflation will be here to stay for the short to mid-term.
In addition, tight border restrictions have left many industries desperately short of skilled people. This has pushed demand beyond supply with the inflationary impact on wages and salaries resulting in a vicious cycle of increased costs causing wage demands which then result in higher costs and higher wage demands.
What can businesses do to manage the impact of inflation on their business?
A business must know its cost of funds and its marginal revenue to marginal costs ratios. These relatively simple tools will assist with key decision making during this period. If you’ve not calculated these for some time, contact your Business Advisor for guidance.
If your costs of funds are less than or equal to the running rate of inflation, then you might want to pre-order and prepay for key inputs now rather than wait for when they are needed. This will both limit the impact of supply logistics problems as well as provide certainty around the price you will pay.
If, for example, your costs of funds are 5% and the forecast inflation for the rest of this year is between 6 and 9%, then pre-ordering and prepaying means you’ll pay less for supplies than you would in the future.
Knowing your marginal costs and marginal revenue (and updating these regularly) will also help you to decide whether to accept or decline certain orders and indicate whether to increase your prices. Inflation will increase your marginal costs of providing certain goods or services. That could be a result of increasing prices for the components or increases in direct overheads or both. Either way, knowing what these are will help to ensure you don’t sell your products at a loss.
If you provide credit terms to your customers, be wary of terms creeping over longer periods. Inflation reduces the amount of ‘real cash’ you will receive if you get paid later. That was not such an issue when inflation was 1 or 2%. But when it creeps up to 6 or 7%, the impact of extended terms of credit reduces the value of that future payment. Consider introducing interest rate terms for payments after a fixed period. In short, be watchful of your clients using you as an interest free bank.
Talk with your key suppliers and customers. They will also be feeling the impact. If you can arrange pre booking purchases where you don’t need to place a deposit (or only need to place a relatively small deposit) and the price is fixed, this will certainly assist you.
As the owner of an avocado orchard, my family and I are faced with severe supply limitations and inflation running at close to 15% within the industry. To mitigate some of the impacts, we have extended our seasonal overdraft (and shifted some of that into fixed term loans) and pre-ordered goods for next year at prices fixed now. Our suppliers were open about what price increases they were about to implement so pre-ordering was a simple decision. In some cases, only a small deposit was required.
It’s also a great time to run your eye over costs and consider luxuries versus essential items, taking into consideration that luxuries or ‘nice to haves’ are probably significantly higher than they were last year. You may decide to keep them but be aware they might cost significantly more than last year. You will know what those items are.
Inflation also has a direct impact on employees. Businesses need to be conscious of the extra stress employees may be feeling as costs rise. They may be stretched as the interest rates on their mortgages increases or as rental rates rise. That stress can manifest into lower productivity or increased absenteeism. An employer who recognises these pressures and treats their people well with valued support, transparency and communication, will likely weather a period of rising inflation and a shortage of labour supply. Something you could offer employees is access to an external budget adviser or financial planner.
I do not expect we will return to the inflation seen during the late 1980s (when I was working for a major trading bank granting overdrafts at 33% interest), but the Reserve Bank is facing a challenging period where it must juggle many things, of which increasing inflation is one of them. Meanwhile, for businesses coming out of COVID and now heading into uncertainty around inflation, it is time once again to reassess costs and spending while addressing the impacts on businesses and their employees.
