How Does Inflation Affect Small Businesses? Understanding the Impact Rising Prices Have on Your Company

You can hardly turn on the news or listen to a podcast these days without hearing someone talk about inflation. You know inflation can have a profound effect on the economy and businesses.

But how, specifically, can inflation affect your small business?

With the increasing cost of goods and services, small business owners may struggle to maintain profitability and keep up with the competition. Understanding the effects of inflation on small businesses is crucial for your survival and growth.

In this article, we will explore six ways inflation impacts small businesses and what measures can be taken to mitigate those effects.

What Is Inflation and How Does It Impact the Economy as a Whole?

Inflation is the rate at which the general level of prices for goods and services is rising — and subsequently, the rate at which purchasing power is falling. It is measured by the Consumer Price Index (CPI) and is expressed as a percentage.

Inflation has a significant impact on the economy as a whole. When prices rise, the value of money decreases and people can’t purchase as much. This can lead to a decrease in consumer spending, which can hurt businesses and slow the economy.

Inflation can also lead to higher interest rates, making it more expensive for people and businesses to borrow money.

On the other hand, inflation can stimulate the economy by encouraging businesses to invest and expand. It may also prompt customers to spend money quickly before prices rise any further. This may result in increased economic activity and growth.

6 Effects of Inflation on Small Business Owners

Let’s focus on how inflation affects the state of small business finances. Here are six problems you may see as a result of inflation.

#1: Rising Costs of Goods and Services

During inflation, overhead costs such as …

• Raw materials
• Labor
• Utilities; and
• Other inputs

… tend to rise. 

These periods of rising costs often prompt small business owners to prioritize higher-margin goods and reduce the production of low-profit products.

Small businesses can also struggle to pass on increased costs to their customers, as they may be competing with larger businesses that have more bargaining power.

#2: Decrease in Consumer Spending and Sales

Inflation can negatively impact small businesses by reducing customer spending and sales. As the cost of goods and services rises, consumers have less disposable income to spend on non-essential items. This leads to decreased consumer demand.

Small businesses, which often operate on tight margins, can struggle to maintain profitability in this scenario. They may be forced to increase prices to cover rising costs, but this can further reduce consumer demand and lead to even lower sales.

Additionally, larger businesses — who often have more bargaining power — may be better equipped to absorb the impact of inflation, making it even more challenging for small businesses to compete.

#3: Difficulty Planning and Budgeting for the Future

Inflation is a major factor that makes it difficult for small businesses to plan and budget for the future. When prices rise and the cost of goods and services increases, it can become challenging for small business owners to determine their operating expenses and make accurate financial projections.

Since inflation affects everything from the cost of raw materials to employee salaries, this makes it difficult for small business owners to predict their expenses and allocate resources effectively. Thus it becomes harder to remain competitive and maintain profitability.

In addition, small businesses often operate on tight budgets and may not have the resources to cope with unexpected expense increases. This can lead to a cycle of uncertainty where owners cannot invest in new opportunities or expand their operations. 

#4: Impact on Interest Rates and Financing Options

As the Federal Reserve raises interest rates to keep inflation in check, it becomes more expensive to borrow money. These higher rates can make it difficult for small businesses to access financing options.

This can limit their ability to:

• Invest in new projects
• Expand operations; or
• Meet unexpected expenses

However, inflation may work to your advantage when it comes to older debt.  Since small businesses with fixed-rate loans and credit lines are able to pay at their old rates, this debt now becomes cheaper in comparison to new funding. 

#5: Changes in Inventory Management

As prices rise, it gets more expensive to acquire and store goods, leading to changes in the way small businesses manage their inventory.

Small business owners might opt for just-in-time (JIT) inventory management, which reduces the amount of stock on hand. JIT can help minimize storage costs and reduce the risk of inventory becoming obsolete.

Small businesses may also choose alternative suppliers or shift to lower-cost products to reduce costs. However, this can come with its own risks — such as reduced quality or longer lead times.

#6: Supply Chain Disruptions

Inflation in the supply chain of a small business can disrupt operations and cause harm to the bottom line. As the cost of goods increases, small business owners struggle to maintain profitability while still delivering quality products and services to their customers.

These bottlenecks can cause goods to become scarcer, making prices rise even more. As a small business owner, you may want to consider changing up your normal vendor list to give you an edge over your competitors, even if that means a short-term increase in costs.

Are All Small Businesses Affected Equally By Inflation?

No. Some small businesses will feel the sting of inflation more than others.

That’s because when people have less disposable income, they tend to prioritize their spending toward essential goods and services. Purchases geared toward things like … 

• Travel
• Entertainment; and
• Luxury goods

… usually drop in times of inflation. So if your business centers around nonessential items, you’re likely to face a bigger impact from inflation than those who provide things people can’t live without.

6 Strategies To Help Small Businesses Mitigate the Effects of Inflation

#1: Implement Cost-Cutting Measures to Stay Competitive

Some strategies for reducing expenses during times of inflation include:

• Automating processes to reduce manual labor needs
• Evaluating suppliers to find better deals
• Using technology such as cloud computing to reduce hardware/software costs
• Implementing energy-efficient measures to lower utility costs
• Outsourcing non-core functions like accounting and IT
• Negotiating leases for office space or equipment
• Regularly reviewing expenses and cutting unnecessary items

All small businesses are different, so every strategy we’ve suggested here may not work for you. It’s important to explore and experiment to see in which areas you can cut costs effectively.

#2: Focus on Productivity

Since wages usually rise during inflationary periods, focusing on productivity can help ensure you get more bang for your buck from your payroll expenses.

You may try experimenting with a hybrid work model in your small business to cut in-office costs and make your workers more efficient. There are several different ways to implement this, the one that fits best for you may depend on your business type and employee personalities or work styles.

#3: Increase Prices Without Losing Customers

Be open with your customers about your costs and prices. People will remain more loyal when they understand you are struggling just like they are, but you’re doing everything you can to be fair and keep their business.

They will probably respond better to planned or incremental price increases along the way rather than a sudden surge. 

You may also want to give faithful customers discounts or longer payment terms if possible so they’ll stay devoted to your brand when they are choosing what parts of their budgets to cut.

#4: Do What You Can To Keep Your Existing Staff

It’s much more cost-effective to keep your existing staff than to have to hire and train new workers. 

Your employees are feeling the effects of inflation too, so hearing their concerns and doing what you can to help them will make them want to stick around. You’ll benefit from their experience and save time and money on the hiring process.

#5: Consider the Value of Leased Equipment

You may be leasing business equipment that was initially too expensive to purchase outright. But now that prices have risen due to inflation, the original purchase terms are probably cheaper than the current market price for new equipment.

If you have the opportunity to buy your leased equipment, it’s probably a good idea to take it.

#6: Evaluate Your Cash Flow Management Systems

If you aren’t regularly examining how your business manages cash flow, chances are you’re wasting money somewhere. Automating tasks — like accounts payable and receivable — whenever possible can help mitigate this.

In times of inflation, it’s especially important to maintain liquidity whenever possible. This may be in the form of available cash or access to a line of credit.

If you opt for using credit, do some research and make sure you get the best terms possible for long-term growth and success.