What is inflation and why does it threaten my business?

Lets say you sold a customer something for a price $200 in 2021. The cost to you of materials, labour, admin, etc etc was $100. So you made a profit of $100 (lucky you!)

Then, you made the same sale of the same product to the same customer in 2022. The customer again paid you $200 and it cost you $100 to provide that product. What was your profit this time? It was $90.09.

Why? Because inflation pushed up the price of all of the things you needed to purchase to make the same product you sold the client (“inputs”, as your accountant would say). So you actually had to spend $109.91 to make exactly the same product.

The other way to look at inflation is to say that money becomes worth less over time. $100 in 2021 is now worth $90.09. To give you an idea of what that means – let me give you an extreme example.

Hyper inflation in post World War One Germany was so bad that people were taking wheel barrows full of money to buy loafs of bread. Money became virtually worthless.

Inflation is always with us but the Reserve Bank of Australia (along with most central banks) try and keep it down to around 2% to 3% a year. This year the inflation rate has been around 9.91%.

If you would like to calculate the effect of inflation over time the Reserve Bank of Australia have a handy calculator you can try HERE.

We’ve all seen on the news the reasons for this. Some of them are local and some are international. Floods across Australia are local. War in Ukraine is international.

One thing to remember is that some businesses will be much more affected than others. The inflation rate is an average across everything. But it’s some things in particular that are is driving up the inflation rate. Energy costs for example. If your business is using a lot of petrol or electricity, you will be much harder hit than a business that is providing online services.

But every business needs to be preparing itself and factoring in what it needs to do.

Consult with your accountant. Small business people are busy running their businesses and aren’t used to or have been trained in looking at the nuts and bolts of of inputs and outputs.

What direct and indirect costs do you have? What and how are costs affecting what you are supplying to your customers.

But you also need to look at how this affects your customers as this will have a direct relationship to what they spend and how they spend it – or even if they spend it.

Australians have been very lucky for a very, very long time. Unbelievably low interest rates and and uninterrupted economic growth for decades has left us badly prepared to weather storms. In the 1980’s inflation got to 20%. It won’t get that bad this (hopefully).

The main way central banks try to throttle inflation is by raising interest rates. So another thing for you to consider is how increased borrowing costs are going to affect you.

So what do I need to do?

Work out what things are costing you right now. Work out how quickly those costs will increase (some things will rise much faster than others).

Which is best – decreasing your margins or increasing your prices to customers? Many businesses go broke because they wait too long to increase what they charge. But if you increase prices and your competitors don’t – then you will lose business.

Customers willingness to buy things (and when and how) are affected by inflation and you need to consider that as well. The bottom line is that your customers have less money to spend and they are going to be increasingly careful about spending it.

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The other thing that makes this difficult is that customers and businesses are not used to dramatic price increases. It’s been a long time since Australians have seen such large (as opposed to incremental) changes in prices. $2 lettuces becoming $10 lettuces is a psychological shock to the system.

It’s easy to say inflation is 10% now so I will tack on an extra 10% on everything I sell on Monday morning. But what will your customers think about that? How will they react?

There may be some things that only require a 5% increase (because the costs to you are less), while others really do demand a 10% increase. But it might also be better to have smaller cost increases and absorb some of the costs yourself.

Another thing that many businesses never consider is to stop offering some products (or change them). Or can you value add to your products to make price increase more palatable?

Is it possible to change how you source supplies?

They only way to to know is to do research.

Consult with industry groups and colleagues and research what everyone else is doing. You need to have the courage to raise a price if you need to but also know how to do it in a way that will not alienate your customers.

One of the big imponderables is how long is this going to last. If the war in Ukraine ends today then energy prices will fall quickly. If it drags on for years then they could rise even higher – possibly much higher. That’s just one example of what could affect inflation.

Talk to your accountant. I mean really talk. Not a quick phone call. Sit down with them and go over what your costs are and put in place regular monitoring of fluctuations in costs to you.

Remember, your accountant is trained in profit and loss, identifying trends and studied theoretical and historical inflation in accounting school (I know what you’re thinking – NO! Accounting school is lots of fun!)

But don’t be too worried. There is a lot of room for optimism. Our economy is still strong. Employment is strong and people are making money. The main drivers for inflation may well be short term.

The main thing is – be prepared and be flexible.