Protecting your business against rising inflation
Having navigated their way through the pandemic, many businesses (not unreasonably) may have thought they were in the clear. However, they soon faced another challenge: inflation. Regardless of business sector, rising prices have affected the cost of everything from labour and materials to machinery and services.
In Canada, the latest data places annual inflation at 8.1%. However, this is an average inflation rate, and some costs are increasing at a much faster pace – timber and diesel are just two examples. The war in Ukraine, uncertainty over the future impact of Covid-19, and ongoing supply chain issues are just a few causes of higher prices. As a result, businesses are fighting inflation for the first time in a generation.
We’re also seeing workforce changes arising out of the pandemic. With unemployment at post crisis lows, it’s a seller’s labour market and many workers are cashing in. The global impact of the Great Resignation has not been consistent, and anecdotal evidence suggests a new level of mobility and confidence among skilled professionals. Their services are in demand and they’re not afraid to look for new opportunities that maximise their market value. Naturally, this drives up wages and increases costs for businesses, many of which are still navigating their way out of Covid-19.
While inflation is creating challenges for business, there are steps you can take to mitigate its effects. Here are some suggestions for dealing with rapidly rising prices.
Evaluate your revenue streams
If you sell discretionary goods or services, it’s unlikely that you can compete by adjusting prices to fight inflation. Instead, consider reconfiguring your revenue forecasts to accommodate inflationary pressures and set realistic revenue targets based on prevailing marketing conditions.
Review labour costs
Wages are creeping up, especially in knowledge based sectors and industries where skilled trades are in demand. These increases can have a negative effect on profit margins, so factor this into your revised forecasts. In areas of price inelasticity, where demand is not price sensitive, businesses can raise prices to protect margins as demand drops. Most other businesses need to reduce costs to retain customers; keeping labour costs under control is vital when trying to protect squeezed margins.
Find other cost savings
As prices increase, you may need to find ways to reduce costs across all areas of your business. This could, for example, include making redundancies or finding new efficiencies. The goal here is to cut costs and improve your return on operating investments without compromising the quality of your products or services. Businesses should also look at securing long-term contracts with suppliers while fixing costs at current prices.
Consider borrowing now
With the spectre of rising interest rates hanging over businesses, it makes sense to secure your operating line of credit at current rates. Borrow now for capital acquisitions and take advantage of fixed long-term rates where possible.
Take steps to retain your customers
Eventually, you’ll almost certainly need to increase your prices. Some customers may resist, so be proactive. Consider loyalty programmes and other incentives to help mitigate the risk of customers seeking alternatives to your products or services.
To achieve your business goals, you may need to consider increased automation to bring operating costs down and maintain profit margins. Depending on business sector, this will look different; for example, manufacturers might automate with new machinery while an online service provider might invest in technology that reduces the need for direct staff involvement in digital sales activities.
Have cash on hand
Remaining liquid is a good hedge in times of financial crisis. Inflation reduces the buying power of cash, but it may be feasible to use surplus cash to buy equipment that strengthens your business and makes it more efficient.
Look for opportunities to diversify
In foreign markets, inflation may not be having quite the same impact as it is at home. This can present opportunities to export more. Perhaps your currency has weakened against other currencies, making your goods and services more attractive to buyers. Use your website and social media channels as a tool to target foreign markets and customers.
Analyse your financial ratios
Pay attention to your company’s financial ratios on any outstanding banking agreements and be prepared to reduce debt or renegotiate rates with your bank. As interest costs increase, this can reduce ratios such as debt to tangible net worth, and debt service coverage. Higher labour and other input costs, without a corresponding increase in sales revenue, will not only reduce your operating profit, they will also reduce your earnings before interest, tax, depreciation and amortisation (EBITDA), a key measure of financial performance studied by banks. Thinking proactively and acting before the bank begins scrutinising your books will help to reduce the likelihood that you’ll be pushed into making ill-timed strategic decisions in the face of mounting financial pressure.
Managing costs and cash flow is critical in the current operating environment. Professional tax advisers and accountants are an indispensable resource when analysing your balance sheet and making changes to improve your organisation’s financial position.
About the author
Hartley has served as an assurance partner with Russell Bedford’s Toronto member KRP for more than 35 years, having first joined the firm in 1985. He is responsible for a large and diverse client base of owner-managers, entrepreneurs, family-owned businesses and not-for-profit organisations. He has worked with clients across a wide range of industries, experience that helps him provide clients with the very best strategic financial advice.
Hartley brings expertise in multiple disciplines including accounting, audit, financial management, as well as estate, corporate and personal tax planning. He has published several articles and presented seminars—on topics ranging from financial reporting and business acquisitions, to taxation and succession planning—to various industry groups and professional organisations.