In February, the Bureau of Labor Statistics reported that prices increased by 7.5% YoY. That is the highest level of inflation that the country has experienced in 40 years. In March, the bureau reported an even higher 8.5% inflation compared to last year.
Inasmuch as citizens may be particularly worried about the declining purchasing power of the US Dollar, businesses are directly affected also. This article highlights important things that accounting firms and finance departments at corporate bodies need to know about the rising inflation.
The current inflation report
To begin, here’s a quick breakdown of the current inflation report.
According to the March 2022 CPI report, there is an 8.5% increase in prices vs last year. This is 0.8% higher than prices from the February report.
The highest price inflation was experienced in energy consumption. According to a recent release by the BLS, the price of fuel oil was up 70.1% compared to last year. The price of gasoline was up 48% compared to last year. These spikes may be attributed to the Russia-Ukraine war.
Automobiles pulled some weight on the CPI also. The cost of used cars and trucks went up 35.3% compared to last year while new vehicles got 12.5% more expensive.
The healthcare sector showed the lowest price changes in the past year. Medical commodities showed the lowest change, increasing only 2.7% while the cost of healthcare services increased 2.9% compared to last year.
While the cost of housing only increased by 5% in the last 12 months, the cost of food has left consumers somewhat hungrier. Home-made food now cost 10% more than it did last year. Fast foods and away-from-home foods now cost 6.9% more than they did last year.
Although it appears that these price changes affect consumers directly, corporations –run by consumers and often considered as consumers also– are taking a hit.
The impact of inflation on corporate finance
Just like the average Joe, inflation can be nightmarish for corporations if it’s not managed effectively. Some of its subtle and horrific impacts include the following.
Declining purchasing power of corporate funds
The idea of inflation is centered around the increasing cost of commodities and services that aren’t commensurate with the earning power of the country’s working population. The same applies to companies and their ability to increase profitability to an almost unchanging capital.
During times of inflation, the cost of employee benefits, insurance, energy, electricity, and other corporate liabilities increase significantly. The possibility of a company covering these expenses with the same operating capital as the previous year is very slim, especially when the budget is inflexible.
For instance, if Company X had an operating capital budget of $10 million in 2021 and exhausted it in the year, it may find itself trying to cut costs in 2022 if its operating budget isn’t increased to accommodate increases in the prices of commodities and services needed to keep the business running.
Shrinking production scale
During times of high inflation, corporate executives are prone to underestimate capital requirements and overestimate profits. When these estimates are far from reality –negatively, the business is severely affected. Operations are hindered, production scales shrink to fit available capital and, in some cases, employees are laid off to meet profit goals.
Weakened financial strength
Without accounting for inflation, the cost of assets may not be aligned with their current value. Say a production plant that cost Company X $5 million in 2002 may be assumed to cost the same amount 20 years after if inflation isn’t accounted for. In the real sense, however, considering inflation, the plant can be reported to cost significantly more because $5 million would certainly not be enough to set up the same plant in 2022. Therefore, as companies and their assets age, their financial relevance declines. Thanks to inflation.
Business strategies for managing high inflation
In the ‘60s and ‘70s, companies usually increased prices during times of inflation to combat the declining purchasing power of corporate funds. In recent times, a price hike may not be an excellent idea. It could hurt your competitive advantages in severe ways. Instead one –or a combination– of these strategies could suffice.
Prioritize high profit-margin products
Most companies prioritize products sales based on how long they have been in stock. Although this method is useful for reducing the waste of inventory, it is not very effective for managing inflation. Instead, prioritizing highly profitable products and recommending them to customers can help you make up for the rising operating cost.
Watch relative price changes closely
Reported inflation rates are not even across all commodities and sectors. Items in some sectors experience a considerably higher rise in price than others. In the March 2022 report, for instance, fuel oil climbed by 70.1% while gasoline went up 48%. If your company is energy-intensive, you might want to consider switching from fuel oil to gasoline to help manage the roof-breaking inflation.
Reposition your brands
Sometimes, products are underpriced for the value that they provide. While your business may be doing just fine, periods of high inflation comes with serious financial challenges. It’s crucial that you take the time to identify how your products are underpriced and figure out the best price to offer.
When prices change, however, you may have to reach out to a different demographic of customers, those who recognize the real value of your product. They are the ones willing to pay the right amount for it. This price increase and brand repositioning can help increase cash inflow at a time when purchasing power is on the decline.
It’s difficult to argue that accounting professionals don’t know a tad about the economic impacts of inflation. However, the impacts on business operations and the financial health of corporations have been left in the background for a very long time.
Acknowledging these impacts, accounting for changes in monetary purchasing power, and adopting the right strategy to manage high-flying rates of inflation can aid your business’s survival in times of rapid changes like we are experiencing currently.
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