The tumultuous economy over the last few years has challenged business owners in ways they may not have ever considered. From COVID-19 to supply chain issues to hiring challenges, business owners have been forced to problem-solve in real-time. And as many start to see the light at the end of the tunnel, a new challenge emerges.
Today’s latest challenge: Inflation. We recently hosted a webinar that took a deeper look at the impact inflation has on a business, and discussed ways to proactively prepare yourself for changes beyond your control.
In this article, we’ll expand on some of that guidance by exploring ways to help business owners inflation-proof their businesses.
What is Inflation?
In order to effectively inflation-proof your business, it helps to understand what inflation is. Inflation, in the simplest explanation, is when the cost of goods and services goes up. It’s frequently the result of demand outpacing supply, something we’ve all experienced over the last few years as organizations worked to navigate supply chain issues.
Inflation is calculated by the Bureau of Labor Statistics by factoring in a number of key economic indexes, including the Consumer Price Index (CPI) and the Producer Price Index (PPI). Worth noting is that the Bureau of Labor Statistics offers an inflation calculator that provides a look at inflation based on the CPI for urban consumers.
So what do you need to know? Inflation can lead to higher energy costs, supply chain issues, and labor shortages. As you can probably guess (and have likely already felt), inflation has a direct impact on an organization’s profitability.
Profitability and Cash Flow
Many organizations think about profitability the wrong way — they’re often solely focused on growing revenue as the only means to improve cash flow, increase salaries or become more bankable. There is a more effective way you can think about this, however: maximize your Gross Profit percentage (calculated by Gross Profit / Sales).
A good place to start is to look at your cash flow to understand where you can grow revenue and reduce costs.
Cash flow is quite literally the flow of cash in and out of your business. The availability of cash ultimately determines an organization’s ability to continue operating because there is money available; the organization has liquidity.
But the important part of cash flow is timing. If costs are continually increasing, as is the case with inflation, organizations can find it more challenging to pay bills, cover employee costs, or pay for equipment and materials to produce their goods and services, even if the organization is profitable. The timing of when those expenses are due and when the cash comes in is incredibly important to plan for. Organizations that experience seasonal peaks should pay particular attention here.
Having a clear plan will enable you to better manage your cash flow. When developing your plan, it can be helpful to consider your money needs falling into one of three buckets: short-term outlook, mid-term planning, and long-term spending. Then think about what changes you might need to account for to see past the next three months.
With a better understanding of your cash flow, you can better identify opportunities to make cost-saving changes. This is where monitoring your gross profit comes into play; by monitoring the gross profit, and setting a realistic gross profit margin goal, you can see what changes you make have a positive impact on your bottom line. It can also help you create a more strategic plan to ensure you’re prepared for any unexpected changes, such as prolonged inflation.
How You Can Protect Your Business Against Inflation
To truly inflation-proof your business, you must be well-versed on the ins and outs of your cash flow. Here are some areas you can review to identify potential cost savings to help make your business more profitable:
In each of these considerations, you have the opportunity to differentiate your business to help it stand out. This also introduces you to new pricing strategies. Though reducing prices may feel like the right thing to do to attract and retain customers in tough economic times, the reality is that you’ll need to sell more products or services in order to make up the difference to reach your target gross profit margins.
Increasing prices, however, is a strategic approach to maintaining market share while also helping you offset higher costs. And the increase doesn’t need to be drastic. A 2% increase, for example, is relatively minimal, and a pricing increase aligned to new product bundles can be an effective marketing technique.
The Emergency Fund
Understanding where your cash is flowing in and out of the business can also help you determine how to establish your emergency fund. A line of credit brings flexibility to cash flow for businesses, granting business owners access to capital when needed. In many cases, a line of credit can help businesses cover the gap between when expenses are due and when revenue comes in.
But our advice: Don’t wait until you need it. Think and plan ahead. Work with your banker to understand if a line of credit is a good option for your business before you need it.
Moving Forward with Cautious Optimism
Though there are often unexpected challenges business owners face, there are many strategies that can help you inflation-proof your business. Understanding your financial statements, and knowing how to read and interpret the numbers, will give you a leg up on knowing where and how you need to implement strategies to protect your business.
A parting tip: Don’t shy away from the pain points. Those could be the areas with the greatest potential for growth.
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