Inflation has the potential to affect all aspects of the economy, from business investment, employment rates, and consumer spending, to tax policies, government programs, and interest rates. Understanding inflation is fundamental to investing as inflation can reduce the value of your returns on investments.

What is inflation?

Inflation refers to the general rise in the price of goods and services such as housing, clothing, food, recreation, transport, etc. It measures the average price change in the basket of services and commodities over time. It is measured in percentage terms.

Many businesses have experienced a challenging past 12 months. The pandemic and resulting quarantine measures may be starting to ease, but companies still need to face the prospect of high inflation on the horizon.

While inflation was on a downward trend previously, the Federal Reserve just raised its estimate of average inflation this year from 3.4% to 4.2%.

An increase in inflation has a number of effects on the economy. First and foremost, it erodes purchasing power as the cost of retail goods and services increases. It can also raise the cost of borrowing as interest rates increase due to increased risk.

Inflation increases can also fuel further inflation, creating a feedback loop. As people spend more quickly to reduce the time holding depreciating currency, the supply of money is greater than the demand — so the purchasing power of the currency falls at an even faster rate.

Strategies to Help Your Company Weather Inflation

Get spending visibility:

High-resolution spending visibility is the foundation of any expense management capability. It enables managers to fully understand where money is spent and who spends it. In an inflationary period, it is critical to establish repeatable, end-to-end, actionable visibility of spending by cost category, business process, function, and business unit.

This is the foundation for all other productivity efforts. It enables the right level of accountability throughout the organization to ensure that all decisions are made knowing the full impact on the P&L.

How inflation impacts small businesses.

While you may be feeling inflation pressures already, it is possible inflation has not yet impacted your small business. Inflation ripples through the economy in different ways and at different times, impacting each business in unique ways.

The immediate impacts of inflation are supply shortages that prevent finished goods from being completed. Consider, for example, how Ford has thousands of nearly finished but still unsellable F150 pickups waiting for computer chips to come in.

Manufacturers large and small can have millions tied up in inventory-in-process while awaiting for precious parts to come in. Those who embraced the industry best practice of Just In Time Manufacturing (JIT) are especially vulnerable today to shortages.

Even if your business is not experiencing raw material shortages, you may soon hear your workers demanding higher pay. That’s because the company down the road from your business is offering higher and higher wages to clear out their backlog and keep up with strong demand.

Or, if you have lower-wage workers you may find them priced out of your geography as housing prices rise. We see this happening every day in Denver, where CFOshare is located. With an average home price of over $500,000, only professionals can afford to own a home in Denver, driving blue-collar workers to other states like Texas.

How Inflation Affects Asset Values

While inflation’s effects on the economy and asset values can often be unpredictable, history and economics offer some rules of thumb,

Inflation is most damaging to the value of fixed-rate debt securities because it devalues interest rate payments as well repayments of principal. If the inflation rate exceeds the interest rate, lenders are in effect losing money after adjusting for inflation.

This is why investors sometimes focus on the real interest rate, derived by subtracting the inflation rate from the nominal interest rate.

Why is Inflation Increasing Now?

Asset purchasing policies and activities by the Federal Reserve have significantly increased the amount of cash in the economy over the past 3 to 5 years. This has created inflationary pressures, even before COVID, and SMB’s are being hit especially hard.

Inflation is defined as the devaluation of cash and/or currency, and it is governed by the fundamental macroeconomic laws of supply and demand.  

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