Today, the inflation rate, or speed at which consumer prices rise, is exceptionally high at 5.5%. If you run a small business, you may wonder how this could impact you. 

The truth is, high inflation rates can put your business at risk. But with the right information, you can prepare for and overcome the challenges to protect your finances. 

This guide discusses inflation when it comes to small businesses, including:

  • What is inflation?
  • What are the effects of inflation on small businesses?
  • How can you overcome these challenges?

What is inflation?

Inflation is when the cost of products and services increases over time, decreasing the value of currency. You can measure it with the consumer price index (CPI), which assesses the average cost of goods and services.

Though this may seem alarming, inflation is a natural part of the economy. If the inflation rate stays around 2%, it’s considered acceptable. 

Still, sometimes the rate spikes higher and more quickly than normal, which can be problematic. When the rates go up fast, they usually go down slow.     

It’s essential to understand the effects of inflation on small businesses, so you can prepare for it and protect your profits.  

What are the effects of inflation on small businesses?

Knowing how rising prices might impact your business is essential to avoid long term financial effects. Let’s go over the main things to consider. 

Reduces business value and profitability

As the worth of money decreases from inflation, your business profits decrease. In fact, you may earn the same amount of cash from each sale, but that cash has less value

Inflation causes prices to rise across the board. Your competitors’ prices and your production costs will grow. So if you charge the same, you’ll benefit from that profit margin less. 

Just like lower monetary value hurts your profits, it also decreases the overall worth of your business. Your assets and overall equity weaken as inflation continues.  

See also: How do you put value on a small business?

Lowers purchasing power

Inflation also lowers your purchasing power, meaning the pound won’t go as far. If you have a £500 monthly spending budget, it may not cover everything you need to run your business. 

Similarly, customers may not buy as much of what they want or need, especially if their income stays unchanged. As a result, you could lose customers and earn fewer sales. 

Increases business costs

Since inflation causes consumer prices to increase, it’ll raise your business expenses too. 

Plus, as a small business owner, your costs could be closer to retail prices than larger companies. This is because you may not mass-produce goods or develop in-house. 

How might your costs increase? First, your suppliers will likely charge you more as production costs rise. Then, you may spend more money on electricity, fuel, and business subscriptions.  

As your expenses increase, you’ll retain less of your revenue and you may even struggle to cover regular financial obligations

Causes supply chain shortages 

Inflation can also impact the availability of goods you sell. For example, it can increase wait times, lower supply, and cause import issues. These things could hurt your supply chain, making it more difficult to fulfil customer desires.  

If you’re dependent on your supplier to run your business and that supplier fails to meet your needs, you could disappoint your customers. Plus, if that supplier drastically raises prices, you won’t have a backup plan.  

Increases your debt on loans

You may consider taking out a loan to help you handle the challenges of inflation. High inflation rates usually translate to high interest rates. So, you’ll pay more interest on your loans, increasing the overall debt. 

Also, if you have debts for your business, inflation could increase the amount you end up paying back on loans. 

How can you overcome these challenges?

Now that you know how rising inflation can hurt your business, you may wonder how to avoid long-term consequences. Luckily, there are a few things you can try. 

Raise your prices

A great way to protect your profits from inflation is to adjust your prices accordingly. You may update them annually to match the rate. 

When doing this, it’s crucial to maintain your customers’ attention. So, consider using a pricing strategy that helps you earn sales. In this case, the competitive or dynamic approach might be the most effective. 

To learn more, check out our article on how to adjust your prices for inflation. 

Assess supply chain risks

If you assess the risks to your supply chain, you can lower its impact on your ability to meet customers’ needs. 

For example, you may notice that you order all your goods from one supplier. So when that supplier increases prices or can’t fill an order on time, it would impact your operations.   

To solve this problem, you may want to diversify your suppliers or negotiate a long term contract to avoid surprise increases. You could also focus on strengthening your supplier relationships and communication. 

See also: How to improve your supply chain management

Plan for inflation 

If you anticipate inflation, it’s much easier to deal with. So consider keeping up with the latest news on the economy to make sure you see it coming. You can also use the Bank of England’s Inflation Calculator to plan ahead. 

Also, inflation will impact you less if you build a savings fund to prepare for increased costs. You won’t need to react after the fact if you consider these effects before they occur. 

Track your finances to plan for inflation 

To prepare for the effects of inflation on small business, you’ll need to stay on top of your finances. Luckily, the right accounting tool can help with that. 

Countingup is the business current account and accounting software in one app. It automates time-consuming bookkeeping admin for thousands of self-employed people across the UK. 

With Countingup, you can track your expenses and earnings with tools like: 

  • Automatic expense categorisation 
  • Receipt capture 
  • Ongoing cash flow insights 
  • Automatic invoice and payment matching

Save yourself hours of accounting admin so you can focus on growing your business. 

Start your three-month free trial today