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How Does Inflation Affect a Business

Last updated: 04 April 2024

Over the past few years, inflation has been a common talking point across many different industries, as well as impacting us in our daily lives. Certain goods and services suddenly became much more expensive, for example, the price of diesel rose by nearly 48% in June 2022, compared to June 2021.

The rise and fall of inflation can create uncertain times for businesses, affecting cash flow, both positively and negatively. This guide is designed to help you through the uncertain times that arise because of inflation and aid you in managing inflation in the best possible way for your business.

What Is Inflation?

Inflation refers to the rate at which the general level of prices for goods and services rises, leading to a decrease in the “purchasing power” of money. When inflation is high, each unit of currency buys fewer goods and services than it did before. Conversely, when inflation is low, the purchasing power of money tends to increase.

As of 2024, the UK Government’s target is to keep inflation at 2%. If the rate of inflation fluctuates too much from this target, businesses and the general public are affected. As an example, if inflation rises above 2%, businesses would struggle to set the right prices for goods, and people may then struggle to plan their spending. If inflation falls below 2%, businesses could be negatively impacted, as goods and services are worth less, meaning people reduce spending and jobs are potentially put at risk.

For frequent up-to-date information, visit online official sources such as the Bank of England and the Office for National Statistics.

What Main Ways Can Inflation Affect a Business?

Inflation can affect businesses in a number of ways. However, the impact of inflation on a business is not always negative. Depending on your industry, you may actually benefit from inflation such as if demand increases for a product you sell or manufacture, for example, as profits could be maximised. However, if you’re affected by inflation negatively, Finance brokers such as ourselves offer a range of solutions to combat inflation. The most common ways in which businesses are affected by inflation include the following:-

Cost of Goods and Services

Inflation typically leads to a general rise in the prices of goods and services. This can increase the cost of raw materials, production, and operating expenses for businesses. Companies may have to pay more for supplies, energy or labour, potentially squeezing profit margins. For example, if your company requires raw materials that cost more than they usually do, you may feel stressed about the implications this may have on your overall profits and the impact on the productivity of your services. However, solutions such as a business loan could help guide your business through difficult times, keeping you afloat whilst inflation rates are high.

Wage Demands

Inflation can put pressure on businesses to increase wages since the cost of living is heightened. Higher wages can contribute to increased labour costs for businesses, especially if they are unable to offset these costs through increased productivity or higher prices for their products or services. To combat this, businesses could consider a long-term strategy for staff wages, such as implementing variable pay or compensation structures, where staff receive commission-based pay, profit-sharing plans or stock options. These all become attractive when inflation reduces and profits rise.

Consumer Demand

Inflation can impact consumer purchasing power; when prices rise, consumers have less disposable income, leading to reduced spending on non-essential goods and services. This can affect businesses that rely on consumer spending, such as retailers, restaurants, and leisure companies. However, businesses that provide essential goods and services may actually make more of a profit when this occurs, since there is a greater demand for the goods they supply, raising profits. If you’re a business that relies on consumer spending for non-essential goods, cash flow lending from a finance broker could provide stability to your business, since fast access to funds and short repayment terms are available.

Interest Rates

In response to inflationary pressures, central banks may raise interest rates to curb inflation. Higher interest rates can increase borrowing costs for businesses, making it more expensive to finance investments, expansions, or day-to-day operations. This can particularly impact businesses with high levels of debt, or those looking to borrow for growth, but don’t let this put you off speaking to a finance broker about available solutions, even when interest rates rise. To avoid being caught out by high interest rates, shop around for the best available rates and compare what finance businesses are offering.

Investment and Expansion

Inflation can influence business investment decisions. Uncertainty about future inflation rates and economic conditions may lead businesses to delay or scale back investment projects or expansion plans. Businesses may also prioritise investments that offer protection against inflation, such as infrastructure or assets that appreciate in value over time. Union Business Finance offers a range of asset finance options so that, in uncertain times, you can invest in the right areas of your business without sacrificing cash flow, irrespective of your industry.

Contractual Agreements

Inflation can affect the terms of contractual agreements between businesses and their suppliers, customers, or lenders. Contracts that are fixed or have long-term payment terms may become less favourable in real terms if inflation exceeds expectations. In order to combat this, businesses may need to renegotiate contracts or adjust pricing strategies to account for changing economic conditions. If you are dealing with a finance broker, make sure you consider the terms of the contract at the start of negotiations to forecast potential inflation rises, and the consequences this could have on the contractual agreements. Strong communication with your chosen finance broker will be your best route to getting a fair deal.

Currency Exchange Rates

Inflation can impact currency exchange rates. This can affect businesses engaged in international trade or exposed to currency risk. Changes in exchange rates can influence the cost of imported goods and raw materials, as well as the competitiveness of exports in foreign markets. Some businesses may benefit from this, especially if they supply to another country which is experiencing an increased demand for the goods you provide, or if they rely solely on trade in the UK, where competitors may be losing out due to currency exchange rates. If you are a business negatively affected by inflation and exchange rates, you may consider using raw materials from the UK in the short and long term, or if this is not possible, instant business loans may be a short-term solution to protect cash flow and access to imported goods.

Positive Effects of Inflation on Businesses

As mentioned throughout, inflation does not always create negativity for businesses. Inflation can create opportunities for businesses to gain a competitive advantage over rivals. For example, if your business is able to adapt quickly to changing market conditions and adjust its pricing strategies accordingly, you may outperform your competitors who are slower to respond. Perhaps the most commonly understood positive effect of inflation is that companies may experience increased demand as consumers spend more to maintain their standard of living, despite rising prices. This can result in increased revenue for businesses, especially if they can pass on higher costs to consumers. Inflation may not always negatively impact interest rates too; it can lead to lower real interest rates, as nominal interest rates may not rise as quickly as prices. This can make borrowing more attractive for businesses looking to finance expansion or investment initiatives.

Why Does Inflation Rise and Fall?

Inflation has been rising and falling over a number of years, for various different reasons. One recent reason for the rise in inflation was due to the Covid-19 pandemic, which created a strain on the supply chain, raising prices. Global conflicts, such as the Russia-Ukraine crisis, have also impacted inflation, especially for energy and food prices, as Ukraine was a major supplier of both energy and food to European countries.

“Demand-pull” inflation can cause rates to rise. This happens when demand for goods and services exceeds their supply, and prices therefore tend to rise. This can occur during periods of strong economic growth when consumers have more disposable income and are willing to spend more. Increased demand puts upward pressure on prices, leading to inflation.

Inflation can also be driven by increases in production costs, such as wages, raw materials, or energy prices - this is known as “cost-push” inflation. When businesses face higher costs, they may pass them on to consumers in the form of higher prices, leading to inflation. Global conflicts, as mentioned earlier, can contribute to this.

However, when the opposite of the previous factors happens, inflation levels can fall. A decrease in demand can contribute to a reduction in inflation, and sometimes even deflation (a sustained decrease in the general price level). If businesses and consumers expect inflation to decrease in the future, they may adjust their behaviour accordingly, such as delaying purchases or reducing price-setting behaviour. These changes in expectations can help reinforce the downward trend in inflation.

Explore Our Financial Solutions to Support Your Business During Inflation

Finance brokers are there to be utilised during uncertain economic times, which is why here at Union Business Finance we offer a range of flexible, bespoke finance solutions to help your business wherever possible. Whatever your needs, we are happy to help - get in contact with us today.

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