Inflation continues to shape the Irish economy, with the annual rate standing at 6.3% as of August 2023. Although this marks a slight drop from the peak levels of 2022, rising prices remain a real challenge for small businesses.
As the cost of goods, services, and living expenses climbs, it’s more important than ever for business owners to grasp how inflation affects their operations. With experts anticipating that these high rates will stick around, understanding and managing this economic pressure is essential for the survival and growth of your business.
What is inflation?
Inflation indexes such as the Retail Price Index (RPI) and the Consumer Price Index (CPI) measure how the cost of goods and services changes over a set period. Inflation is the rate of this price increase, typically calculated over a year. Broadly, inflation reflects the cost of living in a country, but it can also refer to specific areas, such as the rise in raw material costs.
Inflation occurs when a country’s money supply grows faster than its economy. This reduces the currency’s value, meaning each money unit buys fewer goods and services. For consumers, this results in higher costs for everyday purchases.
How does inflation affect small businesses?
Understanding how inflation affects small businesses is crucial for any entrepreneur or business owner.
Inflation can significantly impact small businesses. It can influence various aspects of operations, from pricing strategies to inventory management.
When inflation rises, the costs of goods, services, and raw materials increase. If businesses adjust their prices to reflect these rising costs, they may be able to maintain their profit margins. However, if incomes do not rise in proportion to costs, businesses may face challenges in maintaining profitability, leading to difficult decisions regarding pricing, staffing, and operations.
Here are four key ways that inflation could affect your business operations, particularly your cash flow:
1. Fewer sales
Even if businesses maintain or lower their prices, consumers might still reduce spending. As prices rise overall, consumers may cut back on non-essential purchases and even essentials, leading to a drop in sales.
2. Narrower profit margins
Higher costs can squeeze profit margins. To cope, businesses must adjust their pricing models and carefully forecast profit margins.
3. Reduced access to credit
Suppliers, particularly small and medium-sized enterprises (SMEs), might become more cautious about extending credit. Credit terms could be tightened, or credit availability could be reduced altogether.
4. Enforced changes to inventory
Inflation might make it difficult for businesses to afford or maintain a wide range of inventory. Facing their own challenges, suppliers might reduce their offerings or even go out of business, complicating supply chains further.
While these challenges may seem daunting, SMEs can still navigate inflationary periods by adopting smart strategies. For example, businesses could review and optimise their pricing models rather than increase prices. Strategies such as subscription pricing, bundled discounts, and early payment incentives can help improve profitability.
Effective cash flow management is also crucial. Businesses should leverage cash flow management tools and consider professional financial advice when necessary.
When to use cash flow management tools
The impact of inflation on your business will vary depending on factors like its nature, the products and services it offers, and its location. However, there are universal strategies for managing cash flow, forecasting finances, and making informed decisions during inflationary periods.
Open a business bank account
Separating your personal and business finances through a business bank account helps build business credit and makes it easier to manage accounts receivables and payables.
Track expenses
Utilise expense-tracking software to keep your finances organised. Basic business accounting tools can provide a comprehensive financial overview of your business.
Automate business functions
Automation can streamline various business processes. Retailers, for example, should invest in systems for order tracking, customer loyalty programmes, invoicing, and inventory management to reduce manual workload.
Get professional help
In addition to using the right tools, consider hiring professionals. An accountant can help with tax filing and provide broader financial management guidance, ensuring your business remains financially sound.