Inflation is one of the biggest risks that an entrepreneur is likely to face. While we consumers have various ways to escape the impact of inflation, business owners are bound to bear the brunt of it all. This is because they cannot stop production all of a sudden. They are required to continue while facing the effects of inflation and have a contingency plan in place to take care of damage control. Listed below are the different ways in which inflation affects businesses.
The purchasing power of customers
This is the first and the most natural response to inflation. With increasing prices of products and services, customers try to buy as less as possible and completely do away with unnecessary purchases. If due to increased management costs, prices do increase, customers will start looking for cheaper options and that will drive down the business even further.
Rising cost of inventory
The prices not only go up for us but also for business owners who need to pay money for their inventory. If the price of replacement inventory rises more than the amount of sold inventory then it can end up in a shortage of inventory.
During inflation, businesses find it hard to have a constant marked price on things. There is a term called ‘menu costs’ that seem to add up when the prices are highly variable. This is highly confusing because nobody seems to know where to draw the line. You cannot project costs, you cannot assume a profit margin and the whole economy is an uncertain mess.
A common trend in inflation is the extension of loan portfolios by governments. Businesses, in their quest for expansion, take up loans and hope that the interest rates would be lower. However, in case their new venture or expansion does not work, it becomes difficult for them to pay back the loan amount. Moreover, financial lenders become very strict about giving loans and even if they do, the interest rates are sky-high. Businesses face low liquidity and the ones that are highly dependent on external funding, lose hope of any further expansion.
Wages of employees
Employees of a business suffer the most during inflation. The cost of living increases but the business might not have a great profit margin so it ends up either not giving in to the demands of the employees or cutting back on the already reduced wages. This makes most employees quit work and look for better alternatives.