If you’ve been reading news headlines about increasing rates of inflation, it’s natural to wonder what exactly that means for you. Amidst concerns over rising costs, it’s important to explore the impact of inflation on business. When you go to the grocery store or hire a service, how do the effects of inflation on business change your costs?
Or, if you’re a business owner yourself, how could inflation affect your business plan? Let’s briefly look at what exactly inflation is, then dig into the effects of inflation on business.
What Is Inflation?
In short, a period in which a currency’s purchasing power decreases and prices increase. Usually, inflation happens gradually—around 1-2% per year. However, there are also periods of high inflation, like the 7.5% increase we saw in January 2022.
While inflation isn’t the only thing that causes prices to increase, it’s certainly a notable factor. You’ve probably winced at a higher bill when you buy groceries or fill up your car. If you rent a house or apartment, inflation might spur your landlord to raise the monthly price.
To understand inflation, we have to understand its effects. Let’s turn to the impact of inflation on business.
6 Effects of inflation on business
Since business affects our daily lives in so many ways, the impact of inflation on business is also personally relevant to you. Here are some of the ways inflation can unfold!
1. Prices increase as purchasing power decreases
This is the most obvious impact of inflation on business (since it’s essentially the definition of inflation!). When the dollar is worth less, things get more expensive to compensate.
Prices rise for businesses who have to pay more for inventory costs, rent, labor, etc. In turn, those extra costs get passed on to the consumer. Think about the dollar store becoming the $1.25 store—the dollar isn’t worth as much anymore, so they can no longer accept a dollar for the same products.
2. Fewer people can afford certain goods and services
If things are getting more expensive and wages aren’t rising to match, many people’s budgets have to get tighter. That’s especially the case for non-essential goods.
If your costs for non-negotiable expenses like housing, food, gas, and healthcare increase, that extra money might be coming out of your fun budget. People might eat out at restaurants less, travel less, avoid buying new clothes and electronics, and so on.
On the business side, this means lower sales and profits for the companies facing declining demand. Sectors that struggle during inflation include consumer discretionary areas (automotive, apparel, home improvement, etc).
Financial companies like banks; industrial and transport sectors like airlines and construction; and the materials industry including mining, chemicals, wood and metal, and more.
3. Supply chains could face disruptions
Because of all the upheaval with pricing during inflation, it is intimately connected to the supply chain. Disrupted supply chains can actually contribute to causing inflation in the first place, since scarcity drives up prices.
High inflation can turn this into a vicious cycle. With skyrocketing prices, suppliers may go out of business or face difficulties acquiring the same goods as they did before. Items become harder to find, and the ones you can find cost more. Lack of supply is one of the biggest effects of inflation on business.
4. Saving starts looking less attractive
If the value of your dollars is steadily decreasing, you may come to the conclusion that it’s better to spend it ASAP. After all, why would you hang onto cash as it’s getting less and less valuable?
This is certainly a valid thought! Many people choose to spend their money on assets or invest it in the market when inflation is high. If you have extra cash, you might decide to invest in real estate, buy a new car, or stock up on shelf-stable pantry goods.
However, the impulse to spend is a double-edged sword, because increased spending can make inflation worse. Higher demand + lower supply = prices rising even more.
Investing in stocks is also an option we’ll talk more about later!
5. Interest rates on loans may rise
During periods of high inflation, the Federal Reserve may raise interest rates. They do this to counterbalance the population’s increased spending rates by making loans more expensive and harder to get.
For the everyday person, this tends to look like higher rates on mortgages and car loans. On the business side, it looks like higher interest on business loans, real estate purchases, vehicles, equipment, etc. This can make it more difficult to start or grow a business.
6. Small businesses tend to suffer more
Unfortunately, small businesses are often disproportionately hit by the effects of inflation on business. Big companies tend to have more supplier relationships and more space for inventory. They can also generally afford to keep prices a little lower.
When consumers are trying to save money, they’ll often shop around for the lowest price, which leads them to the big corporations instead of small local businesses. In order to compete, small businesses need a strong value proposition to set themselves apart. Check out this guide to successfully running a side business to help you make a solid plan.
How do you prepare for the effects of inflation on business?
Now that you know the impact of inflation on businesses, does rising inflation have you worried? The best antidote to worry is preparation. Let’s review some tips on planning for and responding to inflation.
1. Evaluate your needs vs your wants
When times get tough, the tough get thrifty. Revisit your budget, or create one from scratch if you don’t have one. Take a thorough look at your spending and categorize expenses into needs and wants.
Look for opportunities to pare down a tight budget and stretch your dollar further. This will help you avoid getting into the paycheck-to-paycheck cycle during inflationary periods.
2. Beat inflation by investing
So, how do you get ahead of the effects of inflation on business? For anyone who’s been holding a large amount of cash in savings, investing can be a smart option to beat inflation. The goal is to get a return that’s higher than the inflation rate. For example, if you get a 10% investment return and inflation is 7%, you’re still coming out 3% ahead.
That said, the stock market obviously isn’t risk-free. If the market goes down, you could just as easily lose value in the short term.
Follow these tips for investing during high inflation. The “cliffs notes” are:
- Diversify your investments.
- Explore Treasury Inflation-Protected Securities. (TIPS)
- Invest in companies that sell essential consumer goods.
- Invest in companies that can easily raise prices and don’t require a lot of capital.
Although the value of cash does depreciate with inflation, it’s still important to have an emergency fund. Emergencies don’t wait until inflation is over!
3. Explore buying assets that hold their value
I’ve already mentioned how some people like to shield their money by putting it into assets that aren’t expected to depreciate.
In addition to certain stocks and bonds, asset classes that have historically provided a good hedge against inflation include:
- Real estate
- Precious metals like gold
- Commodities (if the supply chains are solid)
These can all be great options—but as the Wall Street Journal explains, there’s no perfect way to shield your money from inflation. Every option has pros and cons; risks and rewards. Diversifying and being patient is your best bet.
4. Try to work in an “inflation-proof” field
Whether you’re a business owner, work a 9-5, freelance, or earn money with the gig economy, is your income source stable? Since inflation can disrupt so many industries, this is important to consider. Protecting your source of income is just as important as protecting your savings, if not more.
Check out these recession-proof jobs. These are jobs that will always need doing, regardless of the current state of the economy. If you’re looking to make a career change, some great industries to consider include healthcare, tech, accounting, public safety, government, transportation, legal services, and more.
But if you love your current job, don’t be afraid to ask for a raise. Just remember, if your raise doesn’t at least match the rate of inflation, it’s almost like getting a pay cut.
Leverage these tips to create your inflation plan
After everything is said and done, the most important tip of all is don’t panic! Everyone prefers to live in times when the economy is stable, but that isn’t something we can control.
Channel your best low-consumption, sustainable-living self, pick investments that work for you, and make plans to protect your income. Then, you’ll be ready to weather all the effects of inflation on business!