Inflation: it’s an ongoing concern, and it’s had a significant impact on consumers and businesses alike.

Inflation is when prices rise and purchasing power falls across the entire economy.

Compared to megacorporations with resources and pricing power to spare, smaller enterprises face particular challenges when they’re operating in a high-inflation environment. The good news is that while you can’t influence macroeconomic trends, you have the advantage of being nimble, allowing you to more easily implement some proven best practices to navigate these trying times.

In this article, we’ll explain how inflation affects small and midsized businesses and share a few practical tips for surviving and thriving during inflationary periods.

What Inflation Is (and What It Means for You)

Inflation is when prices rise and purchasing power falls across the economy. In other words, a hundred dollars could buy you more of most goods or services three years ago than it does today. Inflation can have many causes, including supply chain disruptions, stimulus spending, and changes in the labor market. It’s measured and tracked in several ways, the most well-known being the United States Consumer Price Index (CPI), published monthly by the Bureau of Labor Statistics. The CPI is based on a “basket” of consumer goods, from groceries to houses.

A low, steady level of inflation is a normal feature of most economic systems, but problems arise when prices outpace real growth over a prolonged period. For small businesses, negative consequences can include:

• Increased costs of goods sold (COGS) and indirect costs, which can squeeze your profit margins
• Reduced consumer spending, especially on nonessential goods, which can lower your gross revenue
• Higher borrowing costs, as central banks attempt to control inflation by raising interest rates
• Trickier budgeting and planning, as unpredictable price changes complicate forecasting
• More competition from bigger firms that can better absorb costs and leverage economies of scale
• Lost goodwill, as necessary price hikes or supply chain delays may frustrate longtime customers

These factors can compound to present a real threat to your operations. Here’s a simplified example:

Suppose you’re accustomed to buying wholesale porcelain mugs for $10 each and retailing them for $20 at a rate of about 500 per month. That’s $5,000 in gross profit. But when inflation increases, the wholesale price increases to $15, cutting your gross profit in half to $2,500. Besides that, inflation is prompting consumers to bargain-hunt or reduce their discretionary spending altogether, so you’re only getting 400 orders a month. Your gross profit is now down to $2,000, your sales associate is asking for a raise to address their increased cost of living, and the cost of short-term financing is higher than ever due to a succession of interest rate hikes.

The easy answer is to raise your prices to $27.50 or higher, but you’re worried about losing loyal customers. This is a tough situation, but these three strategies can keep you moving forward:

1 Streamline Operations to Reduce Costs

When the price of goods and services are beyond your control, you can still control costs:

• Explore ERP (enterprise resource planning) software and other business management tools to help dial in inventory and service capacity. With improved and continuous forecasting and workflow management, you can reduce the costs of overstocking and overstaffing while better meeting customers’ needs.
• Conduct regular audits of your books to identify unproductive assets you could sell off or underutilized services you could dispense with. A good place to start is by printing a detailed P&L covering the previous 12 months and going line by line through the expenses. Monthly subscriptions to periodicals or software are a common culprit – they’re easy to sign up for and just as easy to forget about, but they can add up.
• Negotiate with suppliers for early payment discounts, extended payment terms, or other concessions they may have more flexibility on than price. If you’re a service-based business, map out your workflow and look for inefficiencies that could elevate direct and indirect labor costs.

2 Refine Your Pricing Strategies

Your customers are feeling the pinch of inflation, too, so make sure to set your prices wisely:

• Align with market trends by researching price elasticity (consumers’ sensitivity to price changes) for your industry and reviewing competitors’ prices. Generally speaking, demand for luxury goods and services is highly elastic, while demand for necessities doesn’t drop as much when prices rise. Consult industry reports and publications by the Bureau of Labor Statistics, the Federal Trade Commission, and other government agencies for useful data.
• Consider dynamic pricing or shrinkflation (reduced volumes at the same price) – but be honest and transparent with your customers. This doesn’t need to be a negative message: If you need to adjust quantities to keep sourcing superior materials, express your steadfast commitment to quality.
• Prioritize retention over short-term profitability – an old rule of thumb says it costs five times more to acquire a customer than to keep one. If you raise your prices by 20% and lose 10% of your clients, the math might seem to work out in your favor, but the long-range implications may be detrimental.

3 Enhance Your Financial Management

Wise planning, careful monitoring, and sound fiscal practices can help you weather unexpected financial challenges:

• Look into affordable digital tools, such as cloud-based accounting and payroll platforms and real-time inventory management systems that give you greater control over your finances and provide actionable insights for lowering costs and boosting revenue. Some accounting programs let you build a virtual dashboard for continuously monitoring key indicators like net cash flow, gross profit margin, and inventory turnover.
• Build up your cash reserve so you have a safety net when costs increase or sales falter – many experts recommend three to six months of operating expenses, with higher volatility and more inventory-heavy enterprises requiring more savings. Commit to socking away surplus revenues and saving up bit by bit with automated transfers into a dedicated business savings or money market account.
• Identify responsible growth opportunities that would enable you to introduce complementary products or services to your existing customer base or to enter new markets. Also, consider investments that have historically served as inflation hedges, such as real estate, commodities, blue-chip stocks, or Treasury inflation-protected securities (TIPS).

Position Your Business for Success

Consult your financial institution for more guidance on staying informed and prepared in challenging economic times.