How Inflation Affects Small Businesses

Rising prices across the economy can cause concern among small businesses. With 92% of the 700 small-business owners surveyed by Business.org/Pollfish in 2021 reporting a rise in “the cost of supplies or services needed to run their business,” deciding how to respond was already a top priority for many companies. That was before inflation skyrocketed to 40-year highs earlier this year.

Inflation impacts businesses in different ways depending on a variety of factors. Small-business owners and managers who are aware of those effects, how they vary, and how they may apply to their own organizations can more effectively prepare to cope with inflation’s potentially erosive consequences. Then, they can more effectively continue to find joy in running their businesses.

Inflation Doesn’t Affect Businesses Equally

Depending on your industry, inflation may not affect your business as much as others – but it's unlikely your business is immune to it.

Essential goods and services and sellers with little competition tend to have less issues even as prices rise. This is because people are often willing to pay higher prices for goods and services they need and can’t easily get elsewhere. When prices rise for an important medical procedure or at the only grocery store in town, customers will likely still pay the costs as long as they can.

But when consumers have less money left over after buying essentials, they start reprioritizing their spending on nonessentials, or discretionary spending. Purchases like luxury goods, entertainment, and travel often see a larger drop in demand because customers are likely to sacrifice those first when funds get tight. If your business provides nonessential goods or services, like a local theater or a tourist-focused attraction, it might face a bigger impact from inflation.

How Does Inflation Affect Businesses?

During inflationary periods, businesses should expect their costs to rise. But some inflationary impacts – both negative and positive – might be less obvious. It’s important to prepare for those too.

Higher Costs

During inflation, overhead costs like raw materials, utilities, and wages tend to rise. Periods of rising costs can mean prioritizing higher-margin goods and reducing production of low-profit products to help hold the bottom line.

Higher Revenue

In the Business.org/Pollfish survey, 89% of the businesses surveyed said they raised prices in 2021. If competitors are raising their prices, you may be able to raise prices without losing many customers. Higher prices can bring higher revenue and positive year-over-year growth.

Falling Demand

The other side of higher prices is lower demand. If competitors are all raising prices, it may seem obvious to raise your prices, too. But customers may also choose to substitute cheaper alternatives to solve their problems if all the competitors in a market become too expensive. If your business offers one of those “cheaper alternatives,” new customers may start coming in. For example, a restaurant may still have the lowest prices in town, but if its patrons need to make cuts, they might stick to buying extra groceries. The restaurant’s loss is the grocer’s gain.

Managing your workforce expenses can get tricky as wages generally rise during inflation, so increasing productivity might require some out-of-the-box thinking.

Inventory Management Changes

As utilities and rent rise, the cost of warehousing goods rises with them. Many businesses might react by reducing inventory, as did 46% of businesses in the Business.org/Pollfish survey. But if your business’s goods have a long shelf-life, it may be wiser to increase your inventory. If you expect inflation to continue to drive up prices over a long period of time, already-made goods can be sold for higher prices in the future while their sunk production costs remain fixed, paid for in “cheaper” dollars. Just try to be sure that the higher prices you anticipate in the future will more than cover your rising inventory management and warehousing costs.

Supply Chain Disruption

Inflation can be caused by many things, but one common cause is disruptions in the supply chain. When supply chains are bottlenecked, goods become scarcer and prices rise as shelves go bare. Diversifying vendors can help give you the advantage over competitors during inflationary periods and may be worth a short-term increase in costs.

Rising Interest Rates

With the Federal Reserve raising interest rates, it’s becoming more expensive to borrow money. Many businesses will likely start fixing older equipment instead of financing the cost of new equipment. However, inflation works to your business’s advantage when it comes to older debt, which becomes “cheaper” compared with new debt. Businesses with existing fixed-rate loans and credit lines keep their rates as the cost of new debt rises for competitors who must seek new funding.

Increased Value for Leased Equipment

If you have the option to buy leased equipment, it can be a lucrative decision during inflationary periods. The original purchase terms when the lease was taken out may be cheaper than the market price for the equipment now, so what once seemed too high to buy may now be a great deal.

Tips for Dealing With Inflation

Aside from just raising prices, businesses can employ other revenue-generating techniques to help get through inflationary times. These tips can help increase efficiency during any period, not just during inflation, and can help your business come out of an inflationary period healthier than ever.

Focus on Productivity

Managing your workforce expenses can get tricky as wages generally rise during inflation, so increasing productivity might require some out-of-the-box thinking. For example, many businesses have found that implementing a hybrid work model simultaneously cut in-office costs and raised productivity. Try to find improvements that work for your business to raise productivity without increasing costs.

Retain Your Workforce

Productivity aside, it’s more cost effective to maintain your existing staff than to hire and train new workers. Don’t forget that your staff is feeling the effects of inflation, too. Listening to their concerns and working with them can be the difference between a well-oiled machine and a window full of help wanted fliers, especially during a period of low unemployment.

Retain Your Customers

Be open about your costs and prices ­– customers may respond better to incremental or planned price increases over big, unexpected hikes. Consider giving reliable customers longer payment terms or discounts to earn more loyalty when they’re choosing what to sacrifice to meet their newly tightened budgets.

Rethink Cash-Flow Management

Many small businesses have more waste in their cash flow management than they realize. Consider automating some routine tasks, like accounts payable and receivable, to free up your staff to focus on finding other cost-cutting measures, like reducing days sales outstanding (DSO) or optimizing your payment systems. Scheduling and spreading out payments can help keep more cash on hand to cover unexpectedly inflated bills.

The Takeaway

Inflation touches every aspect of the economy, but not every business is affected the same way. Understanding why and how their companies might be affected can help small businesses prepare for inflation’s impacts on their industries, customers, and workforces. Many businesses use inflationary periods to invest in systems that can cut costs and raise productivity like automated accounting software and hybrid work programs. Smart business leaders see opportunities in every challenge, and inflation is no exception.