Sign up to receive accounting tips, videos, news and webinar info before anyone else
Inflation has been dominating the news headlines recently with stories of rising prices everywhere including the grocery store, gas station and your neighborhood Chipotle. Yes, even Chipotle is raising the price of your burrito. It’s not just the guacamole that’s going to cost extra on your next visit. Joking aside, inflation is a major problem. The latest data from the consumer price index, shows inflation rose 7% in December 2021. The fastest pace since June of 1982.
The reason why this is such a big deal is because we have our money sitting in our checking and savings accounts. Just by having our money sitting in a bank, earning very little interest, we’ve lost close to 7% in purchasing power due to inflation.
The 10-year Treasury has gone from 1.4% to 1.8%, which is a 40 basis point move. This doesn’t sound like a lot, but it’s around 25-27%. Here five things you want to think about when it comes to financing your business and maintaining your profitability in an inflationary environment.
#1 Short-Term Financing
You always match up a short-term need with short-term financing. If your financing is a cash flow problem, meaning you have to outlay money for products, services or people and collect it later, you use a line of credit for that kind of financing. The interest rates on those lines of credit are going to be going up. What you also need to do is watch the rates that you bill people so that you’re keeping up with inflation in order to maintain your profitability level. Otherwise, what will happen is you’ll start to lose profitability. To guard against that, make sure you’re matching up short-term need with short-term financing.
#2 Long-Term Financing
If you need financing to expand your building, manufacturing capabilities, or buy a big piece of equipment then you want to match up financing with the right term. Long-term financing with a long-term asset. If you’re buying something that’s going to last you 10 years, get a 10-year loan.
Assets will appreciate during an inflationary period. If you get a rate today at 3.5% or 4.5%, and inflation goes to 7%, this loan is going to benefit you. Your asset will continue to appreciate and you’re going to be maximizing the value of your asset investments by locking in long-term, low interest rates today. However, you can’t do this with a short-term need. A short-term need must match up with short-term financing and the same with a long-term need and long-term financing.
#3 Lock in Long-Term Pricing From Your Suppliers
Despite supply chain issues that are exacerbating inflation, see if you can work with your suppliers to lock in long-term service contracts at a given rate. Also, look into locking in long-term leases at a given rate without an inflation rider, but a 2-3% yearly increase instead. What that will do is even if inflation is increasing at 7%, your rent is only increasing by 3%. You’re paying 4% less than you would have had you not secured that long-term lease. Take a look at your business and anywhere that you can arrange a long-term contract with a vendor or supplier, now is the perfect time to do it.
#4 Look at Cash on Your Balance Sheet
How much interest are you earning on the cash sitting on your balance sheet? For most of us with cash sitting in a bank account, the answer is close to zero. This mean you’re losing around 7% of purchasing power of any cash that’s sitting on the balance sheet on an annual basis. In order to turn this around, you need to better manage by the current ratio along with your cash flow and make sure you’re reinvesting your cash either in your business or in outside assets to make better than a 7% rate of return. This will ensure you’re not losing purchasing power on the money you’re trying to be safe with by keeping it on your balance sheet.
#5 Raise Your Prices
Every retailer is raising their prices right now. This is not an opportunity, but a mandatory time to increase yours. Make sure to look at your own prices and raise them to at least match inflation. From there, start examining your pricing every month and look into your cash flow forecasting whenever possible.
Do what we call a three-scenario pricing analysis: an A, B and a C to see if you raise prices this much what’s going to be the impact on revenue? If I raise them by this amount, what’s the effect going to be? We’re all afraid of raising prices because we want to serve our customers at a fair price. We also have to make sure that we’re still making the profits we’ve made in the past, and if our profits are eroded through inflation along with our ability to buy things, then we’re not ultimately serving the mission of our business. Consider raising them even more than the inflation rate to increase your profitability.
These are five ways for getting your business through these inflationary times. Implement the ones that will work for your business so you can maintain or even improve your profitability today.
This post was reviewed by our team of accounting and financial experts. TGG’s mission is to make business owners’ lives better through excellent financial management. We strive to provide the most up-to-date and objective information on accounting-related topics so our readers can make informed decisions based on factual content. All posts undergo a review process with at least one member of our Leadership Team to ensure accuracy.
This post contains trusted sources. All references are hyperlinked at the end of the article to take readers directly to the source.