The Effects of Inflation on US Small Businesses

In this article, you’ll learn all about inflation, including:

• How inflation is tracked
• Causes of inflation in 2022
• How inflation affects small businesses
• Strategies small businesses can use to protect themselves from inflation

The financial media has constantly been talking about inflation over the last 14 months, and the focus is warranted: businesses and households struggle when the prices of goods rise too fast.

In 2021, the Federal Reserve expected inflation to be transitory, lasting several months. But inflation has persisted into 2022 – and shows no signs of slowing down. In May 2022, inflation increased by 8.6% over the past year, the highest increase since December 1981.

The Fed is trying to get inflation under control by increasing borrowing costs, but it’s impossible to say when the inflation rate is going to return to a healthy level. So, you need to develop strategies to protect your small business from inflation – which requires an understanding of inflation at a high level, as well as a handle on the current situation.

How is Inflation Tracked?

The consumer price index (CPI) and producer price index (PPI) are two ways that inflation is tracked in the United States:

• CPI measures the weighted average of prices of a basket of goods and services purchased by consumers.
• PPI tracks the prices that producers receive for their outputs, so it’s a measure of wholesale inflation.

The Bureau of Labor Statistics (BLS) reports both CPI and PPI every month.

What is Causing Inflation in 2022?

At a high level, inflation occurs because there is relatively more money chasing relatively fewer products and services. The “relatively” is key; if the money supply increases by 20%, but production increases by 30%, there wouldn’t be any inflation… unless consumers had been hoarding their savings and suddenly started spending a much higher percentage of their savings.

Is your head spinning yet?

Here’s the good news: you don’t have to do any math to understand why inflation is so high in 2022.

You just need to know a few factors are combining to cause high inflation, the majority of which are related to the pandemic:

• Higher wages: at the onset of COVID-19, millions of Americans lost their jobs, and the federal government provided massive assistance to them. Many people saw their income increase after losing their jobs – due to enhanced unemployment benefits – leading some to the conclusion that their jobs weren’t worth the trouble. The conclusion may not be unjustified. The federal minimum wage is $7.25 an hour, but it would be nearly $26 an hour if it had matched the pace of the U.S. economy’s productivity gains over the last 50 years. In any case, many Americans – with extra cash and few ways to spend it (due to COVID-19 restrictions) – waited out employers who were desperate for workers. This led to labor shortages and an unfavorable labor market for employers. In Q2 2021, for example, wages for hourly limited-service restaurant workers increased by 10%, which is an unusually high jump.
• Rising energy costs: oil prices have soared since Russia invaded Ukraine due to sanctions. According to Madhavi Mehta, commodity research analyst at Kotak Securities, “Supply concerns are unlikely to subside unless there is a resolution to the Russia-Ukraine war, or unless we see a sharp rise in supply from either the U.S. or OPEC.” While increased production in other countries is possible, there is a good chance that oil prices will stay elevated for the foreseeable future.
• Supply chain disruptions: the coronavirus disrupted supply chains worldwide in 2020. There was hope that there wouldn’t be any more supply chain issues in 2022, but the war in Ukraine and lockdowns in Shanghai and other key cities across China are hurting supply chains this year. There’s no guarantee that supply chains will get back to normal anytime soon, so prices of certain products and services may continue soaring.
• Strong demand: in a March 21 speech, Federal Reserve Chairman Jerome Powell said, “strong demand, especially for durable goods,” contributed to “surprisingly high inflation.” The federal government spent trillions of dollars during the pandemic, and a good percentage of that money went directly into Americans’ pockets via stimulus checks. As stated earlier, there were few places to spend that money during the worst of the pandemic, so a lot of that money sat in bank accounts. With the U.S. basically back to normal in 2022, however, people are now spending their pandemic savings.

As you can see, some of these issues may be resolved in 2022, while others may persist into 2023. In addition, the Federal Reserve’s actions are likely to lower inflation. This means there is a good chance inflation decreases over the next year, but it could remain above pre-pandemic levels for a while.

How Does Inflation Affect Small Businesses?

In an inflationary environment, the cost of inputs increases for small business owners. According to the Q2 2022 CNBC SurveyMonkey Small Business Survey, 75% of small business owners are seeing increases in the cost of their supplies. This leaves small business owners with two choices, neither of which are appealing:

1. Keep prices the same, and experience lower profitability.
2. Increase prices, and risk declining sales.

And here’s another way inflation affects small businesses: the cash in your business bank account loses purchasing power.

In some cases, you may no longer be able to afford something essential for your business. Let’s say you’ve been saving up for a down payment on a plot of land to build a new facility – you expected to pay around $400,000 and want to make a 20% down payment ($80,000). But the price increases to $600,000, so the down payment increases to $120,000. You might have to delay the acquisition of an important asset if you face this type of situation.

Strategies Small Businesses Can Use to Protect Themselves from Inflation

Let’s look at some strategies entrepreneurs can use to survive – and possibly thrive – in our current inflationary environment:

Raise Prices

The aforementioned CNBC survey found that only 40% of small business owners are increasing prices, which means many small business owners are not passing higher costs of goods sold on to their customers. As stated earlier, there is the risk that increasing prices results in declining sales, but you can take steps to determine how higher prices would affect your business. Here are a few things to figure out:

• Are your customers able to pay higher prices for your product or service?
• Is there a cheaper alternative?
• Does your business sell discretionary items?

The answers to these questions determine whether or not and how much you should increase prices.

If you decide to raise prices, you may want to communicate the increase ahead of time so your customers have time to adjust to the difference.

Offer Non-Financial Incentives to Employees

The cost of living is likely increasing for your employees rapidly, particularly if they live in an area with a booming housing market. You could bump their salaries to keep up with higher prices, but it’s also possible to offer non-financial incentives.

In a perfect world, you can find something valuable for the employee but not much of a loss for the company. For example, you find that your employees only need 30 hours a week to complete their tasks and projects, but they are currently doing five, 8-hour days each week. In this case, you may be able to give your employees Fridays off – as long as the lack of availability isn’t an issue with customers.

Mitigate Supply Chain Risk

As a small business owner, you have no power over wars and lockdowns… but there are ways to ensure you get your raw materials on time at a reasonable price. Here are a few of them:

• Reach long-term agreements with suppliers. By doing this, you don’t have to worry about rising prices.
• Find backup suppliers. Do you have a supplier in China? If so, you may want to find a backup due to the unpredictable lockdowns.
• Give yourself extra time. While a just-in-time (JIT) supply chain allows you to preserve cash, it introduces risk in the event of delays. A time buffer is a necessity in these times.

You generally want to look for any vulnerabilities in your supply chain and be proactive.

Spend Excess Cash

According to financial experts, small business owners should keep 3-6 months of expenses in cash.

You may be thinking: wouldn’t more than six months be even better – particularly in our current uncertain economic environment?

There would be a good argument for keeping more than six months of cash in a rough economy… if inflation was at normal levels. With inflation high, however, the value of money is declining at a rapid rate. Say you have $100,000 sitting in your business bank account. By late next year, it’s possible that money is only going to be able to buy you less than $90,000 of assets at today’s prices.

Here are a few of your options if you have excess cash:

• Invest in business assets: need a new piece of equipment or building? You may want to buy sooner rather than later to avoid higher prices.
• Develop a better product: due to high inflation, you may have to raise prices to maintain profit margins. Your customers may balk at paying more for the same thing, but if you develop a better product, you don’t have to worry about that reaction.
• Invest in the stock market: yes, it’s been a tough year in the stock market, but there is a decent chance that equities will increase in value over the next year. On the other hand, cash is very likely to go down in value – possibly a lot.

With all that being said, you should only spend your excess cash if you identify a good opportunity. If you have to choose between wasting money and letting it lose value, you should pick the latter option.

You may want to talk to a Certified Public Accountant (CPA) to get help finding ways to use your excess cash – they can help your small business beyond tax season.

Use a Fixed-Rate Loan

There is a good chance that interest rates will move even higher, due to high inflation and the central bank’s actions. With that in mind, you should consider using a fixed-rate loan if you need to buy a business asset – you can lock in your interest rate on Day 1 with this small business financing option. With Biz2Credit, you can get a term loan for $25k to $500k.

The Bottom Line

An inflationary environment introduces many challenges for small business owners, but there are plenty of ways to protect your small business from the effects of inflation. The key is not waiting until it’s too late.

At Biz2Credit, we know that time is always of the essence – particularly with the challenges facing small business owners in 2022. With that in mind, we found a way to provide small business owners with funding in less than a week. For example, Danny Star, the CEO and founder of Website Depot, received funds from his working capital loan in just a few days.

Learn how Biz2Credit can help you fund what’s next for your small business.