Inflation and recession for smaller businesses

The current economic environment is certainly intimidating for business leaders, as inflation and political uncertainties add to the already substantial challenges posed by the pandemic.

However, it's important to remember that these are not new obstacles; inflation and political uncertainty have always been a reality for businesses, and there are strategies for navigating them successfully.

While the current climate may feel like a perfect storm, it's important to approach it with a proactive attitude and formulate a plan to weather the storm.

In doing so, we can come out stronger on the other side.

Here are seven things your business can do to help deal with high inflation:

Determining your real business costs

During periods of high inflation, it's important for businesses to understand the true costs of their operations.

While traditional accounting principles focus on assigning a value to all expenses and income, analysing fixed and variable costs and contribution margin helps decision-makers understand profitability in a more dynamic way.

By understanding the difference between fixed costs (those that stay constant regardless of production levels) and variable costs (those that vary with changes in production), businesses can assess their ability to cover expenses and make decisions about stopping unprofitable operations.

In addition, determining contribution margin - the earnings from sales minus variable costs - can assist in evaluating the profitability of individual products or services.

Managing your cashflow

Staying on top of cash levels can feel like a juggling act.

On one hand, it's important to have enough cash on hand to meet payments and reach profit targets.

On the other, holding onto too much cash can result in its value decreasing due to inflation.

One way to ensure that you have an optimal balance is by regularly reporting on your cash flows and monitoring your working capital.

This way, you'll have a better understanding of where your cash is coming and going and can make more informed financial decisions.

As inflation rises, it often means that the cost of goods and services also increases.

This means that holding onto assets that can be converted to cash in the future can be a wise decision, as they may gain value over time.

In manufacturing, keeping higher levels of stock may also be a smart move as the cost of goods may increase.

Understanding the cost of borrowing

In inflationary economies, being a borrower can have its advantages.

As prices increase, the amount you owe in loans may not seem as significant.

However, lenders have to account for inflation and may raise interest rates accordingly.

This means that it's important for borrowers to stay on top of their repayment schedules to avoid any extra charges.

One way to do this is by hiring a credit controller, who can help ensure timely payments and keep debt under control.

Along with staying aware of inflationary trends, managing debts responsibly can help borrowers maintain their financial stability in the long run.

As inflation rises, bank covenants and borrowing limits can become increasingly strict.

That's why it's important to regularly check on these levels and compare them with your cashflow forecasts.

This will help you avoid any unexpected breaches or fluctuations in income and costs.

It's also critical to reassess the sustainability of your borrowing levels, especially in light of potential changes in interest rates.

Leverage can be advantageous when rates are low, but it can quickly become more costly as inflation increases.

Overall, keeping a close watch on these factors can help ensure smooth sailing for your business.

Scenario planning

One way to stay ahead and anticipate potential challenges during uncertain times is through the use of scenario planning.

This involves modelling the potential impact of changes in inflation, interest rates, supply chain disruptions, staffing changes, and even currency fluctuations on your cash flow.

Scenario planning helps with thinking about potential risks and aids in decision-making to ensure the business remains stable.

Stress testing should also be a part of this process, including exploring some extreme scenarios to see if the business would be able to survive them.

Overall, embracing scenario planning can help reduce surprises and prepare for whatever unexpected challenges may arise.

In today's volatile environment, it's more important than ever to think ahead and stay on top of possible future developments.

Pricing strategies

As a business, it can be tempting to try to offset price increases by making multiple small adjustments throughout the year.

However, this can be an uncertain strategy for both the business and the customer.

Instead, it may be better to plan for one larger price increase and communicate this effectively to customers.

Of course, it's important to weigh the risk of this strategy against the potential benefits for your specific business.

Managing your fixed costs

When it comes to managing fixed costs, it's important to remember that not all solutions are a one-size-fits-all approach.

Yes, cutting costs can be essential in the short term, but it may not always be the most sustainable solution in the long run.

Getting rid of certain resources or equipment now may end up costing you more in the future if replacements become limited or expensive.

It's important to take a balanced approach and continuously assess and manage your fixed costs rather than just going for a quick fix.

This way, you're prepared for both unexpected expenses and financial growth in the future.

Inflation-proofing your business contracts

Short-term contracts may offer more certainty in terms of pricing and negotiating easier exits can also help manage potential risks.

Longer-term contracts may come with limitations, so it's important to understand your options and consider the possibility of walking away from unprofitable deals.

Alice Telfer's article was originally published on the ICAS website.