There has been a lot of conversations recently in the business press about inflation, so I though it would be a timely topic. Why should business owners even care?
Many people were not in business the last time inflation was a serious problem in the United States, so for most this is uncharted territory. Simply put, inflation is the increase of prices over time. There are many things that can cause temporary or permanent changes to prices of goods and services, but inflation is about the rate of that change. Business owners (and everyone else for that matter) want predictable prices. Inflation usually does not vary that much, but when it does it can cause a problem in a hurry.
If the United States enacts a tariff on the goods from a certain country, then the price of those goods in the U.S. go up by that amount. But once its there, however, the amount is fixed. In other words, the price change is built into all future pricing considerations. Now let’s assume that we’re talking about the price of commodities, wheat for example. The price of wheat is determined by a variety of factors, many of which are beyond any one’s control (think weather). So I’m the local baker and I’m trying to price my loaves of bread. Wheat comes in, and I buy a week’s worth, and the price is $10, so I price my bread accordingly. Next week, I place my order for wheat, and the price is now $10.05. No big deal right? That depends obviously on how much wheat you use, but if all other things are equal, that rate of change means that my price of wheat is going to go up 26% in a year. Now I have a problem. I probably have to increase my prices. What affect does that have on sales and profits?
The example I gave was for one business, but when you add it all up, you have the whole U.S. economy. Take one item like oil, which permeates everything we do in the U.S. from transportation to petro-chemicals in drugs. A spike in oil prices can cause a rapid run up in prices across the board.
A second macro-factor would be monetary. If you are in the U.S., you pay your bills in dollars. If there are more dollars than last year out there, then the value of your dollar is less, and consequently, prices are higher. How could there be more money you ask? Well, in the old days, the government had to actually print the dollars (of course no one else could do this, its called counterfeiting, and earns you a trip to Leavenworth). In the digital age, however, printing of money is done literally with the click of a button. An example of this would be the recent Quantitative Easing that the Federal Reserve is continuing through the end of June. The mechanics aren’t important, but suffice it to say that Fed has been “printing money”. The result? More dollars, less value, higher prices.
Inflation is unavoidable, but unpredictable or rapid inflation is disruptive. So what do you do?
- Watch those margins! And I mean religiously. Start with accurate, timely financial information, and don’t be afraid to adjust those prices.
- Educate your customers (you might be helping them out in their business) by explaining why you have to raise your prices. There is a common misconception that somehow people are making more money because prices are going up. In reality, often times business can’t raise prices quickly enough, and are making less money on higher sales dollars.
- Talk to your suppliers. See if you can negotiate better pricing through better pricing terms (pay them early for a discount). Ask them if there is a change in your ordering that could help them save costs and pass it on to you?
- Manage that inventory. Normally, inventory is a problem if you have too much. Doesn’t make you any money if it just sits there. In times of rapidly increasing prices, however, it may make perfect sense to buy now when you know prices are cheaper. There are some basic cost accounting methods to determine order quantities.
It may sound self serving, but it doesn’t change the fact that it is true. Now, more than any time in recent memory, business owners need sound financial advice. If you don’t have it, find it!