There are countless things to worry about when you’re running a business. One of these is inflation and its effect on your purchasing power. Many business owners don’t understand the implications of inflation and, as a result, are often caught off-guard by its effects. This is especially true for those who are mainly concerned with existing operational efficiency and haven’t properly planned for the future.
Businesses need to understand the effects of inflation and how it can impact their purchasing power, or they risk suffering losses and other significant consequences. The following is a guide to understanding how inflation influences purchasing power and ways to mitigate its effects.
What Is Inflation And How Is It Measured?
Inflation is a sustained increase in the general prices of goods and services in an economy. It measures how much more expensive these goods and services have become over time. For example, an apple that cost $1.50 last year may cost $2 this year, which is a 33% increase. It’s essential to understand how inflation influences purchasing power so that you can plan accordingly for it. The following are the two primary ways in which inflation is measured:
Consumer Price Index
The Consumer Price Index (CPI) was created by the US Bureau of Labor Statistics to measure inflation in the United States. It provides a snapshot of how much prices have changed over time and indicates what consumers are currently paying for goods and services.
The CPI measures the cost of a fixed basket of goods and services households typically purchase. This basket of items is referred to as the “market basket,” and its prices are tracked to determine an index that can be compared from year-to-year.
Inflation Rates
The inflation rate measures the annual percentage change in the level of prices for goods and services in an economy using the CPI. The inflation rate tells us how much more expensive these goods and services have become over time.
The CPI for all urban consumers increased by 4.9% from April 2022 to April 2023. This means that the inflation rate was 4.9%.
What Is Purchasing Power?
In economics, purchasing power is the value of a currency relative to other goods and services. It measures how much of one good or service can be purchased with a given amount of money. In other words, it is the number of goods/services that can be bought for a certain price. Purchasing power is determined by the prevailing prices in an economy and changes over time due to the following factors:
Inflation
How does inflation affect purchasing power? Inflation significantly affects purchasing power as it erodes the value of money, reduces the real value of wages and savings, causes disruptions in supply chains that lead to cost-push inflation, and affects investments. Businesses need to have strategies in place to mitigate the potential effect of inflation on their purchasing power, or they risk serious losses.
Supply And Demand
Supply and demand is an economic model describing the relationship between how much of a product or service is available (supply) and how much people are willing to pay for it (demand). If supply exceeds demand, then prices tend to go down. Conversely, when there is greater demand than supply, prices go up. Supply and demand changes can lead to changes in the purchasing power of a currency since it affects what people are willing to pay for goods and services.
Credit And Interest Rates
Credit and interest rates influence purchasing power in two ways. The first is through the cost of borrowing money when interest rates go down. When interest rates are low, businesses can access capital more cheaply and use it to purchase goods or services that will help them increase their production capabilities. This increases their ability to produce more, which can drive down prices and increase purchasing power.
However, when interest rates are high, businesses may find it challenging to secure financing. This decreases their ability to purchase goods and services that they need for production, thereby reducing their purchasing power. Similarly, when credit and loan terms become less favorable, businesses may have difficulty getting access to funds that they need to keep their operations running smoothly.
How Does Inflation Affect Purchasing Power?
Inflation has a big impact on businesses’ purchasing power. The following are some of the specific ways in which inflation can affect a business:
Erodes The Value Of Money
Inflation has a direct effect on the value of money. As inflation increases, prices also increase, and purchasing power decreases. This means that it takes more money to buy the same amount of goods than before. Additionally, creditors may suffer losses when inflation erodes the value of money as debtors can repay their debt with devalued currency. Of course, if your business borrowed money, you could potentially repay the loan with devalued currency.
Affect Wages And Income
Inflation also has a significant effect on real wages. As prices increase, purchasing power decreases, which means that workers have to work longer hours for the same amount of money. This decrease in real wages can be especially detrimental when inflation is higher than wage growth, as it reduces workers’ spending power and makes it harder for them to purchase goods and services.
As a result, hiring new employees and maintaining an effective workforce can become increasingly difficult since you’ll have to pay them more money for the same amount of work if you hope to stay competitive.
Reduces Value Of Savings And Investments
If you have any money in savings or investments, inflation can also reduce the real value of those funds. This means that your savings will not be able to buy as much in the future as they do today. Similarly, if you have any investments, such as stocks or bonds, they may decrease in value due to inflation. Therefore any money tied up in investments must generate a return that is at least higher than the rate of inflation. Otherwise, your savings or investments will lose value over time due to inflation.
Disruptions In Supply Chains And Cost-Push Inflation
Supply chain disruptions can cause shortages, leading to higher prices and decreased purchasing power. This is because shortages can cause companies to pay more for the goods and services they need, which then gets passed on to consumers through higher prices, thereby causing purchasing power to go down. This is known as cost-push inflation, which occurs when there is an increase in production costs.
Significant Effect Of Inflation On Businesses’ Purchasing Power
Inflation can have an enormous impact on your business. For instance, if you don’t have a pricing structure in place that takes inflation into account, it could lead to lower profits as your prices don’t keep up with rising costs. Additionally, if your payment terms aren’t favorable or efficient enough, you may be unable to access the capital needed to purchase goods and services for production. And if your business requires additional workers, you may have trouble affording new employees, since wages may increase due to rising inflation, making it more difficult to find qualified workers.
Because of the impact inflation can have on your company’s purchasing power, you must take steps to mitigate the effects.
Ways To Mitigate The Impact Of Inflation On Purchasing Power
To future-proof your business against the negative effects of inflation, you should consider the following strategies:
- Adjust pricing structure and negotiate favorable contracts on payment terms with suppliers and customers. Doing so puts you at an advantage since you’ll be locked into fixed payment terms and not subject to changes caused by inflation.
- Improve operational efficiency to reduce costs. For example, investing in automation technology or other cost-saving methods, such as outsourcing certain tasks. This can help you reduce costs and ensure a more reliable supply chain that is less susceptible to disruptions caused by inflation.
- Diversify your supplier base. Having multiple suppliers for the same products can reduce your risk of supply shortages caused by inflation. Additionally, it will give you more bargaining power and help you get better pricing from them.
- Implement an inventory management system. An inventory management system can help you monitor and manage your inventory efficiently. This will enable you to reduce the amount of stock held in storage and save on costs associated with purchasing new items. Moreover, it can help you ensure that your inventory is always up to date so that you don’t get stuck with outdated stock when prices increase due to inflation.
- Build strong customer relationships. Engaging with customers and understanding their needs can help you create a pricing structure that factors in the impact of inflation. Additionally, it will allow you to negotiate better payment terms and other deals that benefit both parties.
How Accountants Help Ease The Effects Of Inflation On Your Business
Inflation can be a challenging force to manage. However, with the right strategies and expert advice from an experienced accountant, you can ensure your business is prepared for any price fluctuations. A good accountant can provide financial planning and budgeting advice, as well as cost-cutting measures to help you stay competitive. They can also advise on pricing structures and negotiations with suppliers and customers to prepare your business for any economic conditions.
J.R. Martin & Associates provides this expertise and is dedicated to helping businesses stay profitable even when inflation threatens their bottom line. Our services include comprehensive business planning, tax strategy, and accounting assistance tailored to each business’s needs.
Keep Your Business Profitable With Our Financial Experts
Inflation can have a significant impact on businesses in many different ways. From reducing purchasing power to disrupting supply chains, it’s important for any organization to stay aware of how inflation affects its operations. With careful planning and expert guidance from our experienced accountants, J.R. Martin & Associates can help businesses mitigate the impact of inflation and stay profitable no matter the economic landscape.
Be prepared for inflation’s impact on your business. Seek expert advice from J.R. Martin. Contact us today for your initial consultation.
