Inflation measures the increase in the price of goods and services, which reduces the amount of goods and services that a person or business may purchase with a given amount of money. Consumers usually notice inflation in the rising cost of everyday items like groceries or clothing. Small business inflation is experienced a bit differently.
Small businesses feel the effects of inflation in many, sometimes surprising ways. As prices rise, so do costs, decreasing a small business’s purchasing power and cutting into potentially already thin profit margins. Inflation may be just the first big crack that leads to a spiderweb of challenges for small businesses.
Fortunately, there are a number of strategies to reduce the impact of inflation. From stricter financial management to smart investments in technology, your company can do a lot to combat small business inflation. We go into some specific strategies here.
- Inflation is one of the leading challenges small businesses face today.
- Small businesses tend to feel the squeeze of inflation more than larger ones, reducing profit margins and decreasing purchasing power.
- There are a number of financial and operational steps your business can take to reduce the impact of inflation.
How does inflation affect small businesses?
Although the inflation rate in America has slowed to 3.5% year over year since a June 2022 post-pandemic peak of 9.1%, small businesses continue to struggle with inflation. The U.S. House Committee of Small Business found in April 2024 that 25% of small businesses report inflation as their top problem.
Many factors can contribute to inflation, each of which may impact small businesses. Consumer demand exceeding supply, rising labor costs, rising production costs, and low interest rates can all accelerate inflation.
See a problem? To lower inflation, costs must decrease, but inflation raises costs. That’s why rising inflation is particularly hard to resolve and why sometimes unpopular government actions like keeping interest rates high become part of the formula to reduce inflation. Economics is about balance and restoring that balance to your small business is an easier problem to solve than restoring balance to the entire world economy.
Doing so requires understanding some of the key impacts of small business inflation.
Increased cost of goods
When the cost of raw materials rises—like the ingredients in a sports drink or the fabric used to make T-shirts—small businesses have to pay more to make a product or deliver a service.
If the price of sugar increases, a sports drink company will have to pay more to create the same number of bottles. Either the company must raise the price of the drink, risking turning customers off, or lower the production output, which could create a shortage in the marketplace that fails to capitalize on consumer demand sufficiently.
Even if a company doesn’t create a product, it may struggle with the increased cost of goods. Consider a cleaning service, for example. As raw materials increase for companies that make cleaning products, they may issue price increases to products. As cleaners order more cleaning products, the higher prices cut into their profits.
Not to mention, inflation and the cost of living often go hand in hand. So when inflation rises, and the cost of housing and groceries go up, people need to earn more to support their families. That makes labor more expensive, which makes it difficult for small business owners to pay all of their employees.
Large businesses tend to have greater flexibility in adjusting staffing needs and raising prices. Small businesses do not have that luxury.
Supply chain disruptions
When producers see costs rise, they may have to reduce production volume or cut staff, both of which may impact the supply chain. As overall production volume decreases, small businesses are the first to experience supply chain disruptions.
Large companies spend more money and make larger orders from suppliers. Therefore, suppliers will always give them preferred treatment. As such, small businesses are more likely to experience a negative impact from supply chain disruptions since suppliers will almost always prioritize big clients over small ones.
Increased overhead costs
Overhead costs are fixed costs related to the day-to-day running of the business. You might have an office or factory lease that has a fixed monthly payment, but if you have to renew a lease, expect to feel the impact of inflation. Just like housing costs, commercial real estate costs often rise with inflation. That means renting office or manufacturing space, or leasing equipment will have higher overhead costs.
Higher borrowing costs
One of the principal means the government uses to fight rising inflation is raising interest rates. When borrowing is more expensive, consumers and businesses are discouraged from spending, especially on big-ticket items or risky assets. Since inflation is basically the devaluation of money, higher interest rates are intended to make people save rather than spend, allowing more value to return to the money being spent.
Unfortunately, business loans are often a crucial tool for small businesses looking to expand or create a rainy day fund. When borrowing costs are high, it’s more difficult for small businesses to invest in new equipment, rent new office space, or develop new product lines and initiatives.
How small businesses can prepare for inflation
High small business inflation doesn’t appear overnight, nor will it disappear that fast. Staying prepared for inflation can help small business owners lessen its impact, and several business strategies can help navigate inflation when it’s high.
1 Prepare a financial contingency plan
The best way to solve any problem quickly is proper preparation. This may not be what you want to hear when you’re already dealing with an inflation crunch, but it’s important to note anyway.
Strict financial management and building up healthy cash reserves will make it much easier to navigate inflation increases, economic uncertainty, and periods with reduced consumer spending. Maintaining a strict budget and incorporating contingency planning into your financial management will help your small business stay prepared for anything.
A good way to prepare for tough times is by getting a small business loan to set up a cash reserve. There are many small business loan products available for all types of businesses that can give you the liquidity to build a rainy day fund or provide a cash infusion in lean times.
In addition to a loan, a business line of credit can help your business stay flexible when money is tight. These financing options are a combination of a loan and a credit card. When you’re approved for a business line of credit, you can draw on that funding for any business purpose when you need it and then repay the amount used, just like you would with a credit card. You’re only charged interest on the amount you draw, and only if you don’t repay it within a timely manner.
2 Implement cost-cutting measures
If you’re already feeling the small business inflation crunch, it’s time to cut costs. Cost management will help you identify non-essential expenses and make cuts that won’t lower the quality of your product or service. Employees may love those catered Friday lunches, but that $1,000 every month could be put to better use.
Remember, it’s crucial to continue to offer the same quality of product or service. The last thing you want to do is start putting out a product that is noticeably worse for customers. Purchasing lower-quality raw materials or ingredients, cutting knowledgeable staff, or shortening your operating hours should be the last resort.
When you do make changes, regularly review your business’s financial statements to understand how cuts have impacted profitability and cash flow. Frequently comparing your financial projections to actual performance will help you assess the impact of decisions quickly so you don’t overdo it on cost cuts.
3 Diversify supply chain
Your small business may have some great supplier relations, but they’re likely struggling with inflation, too. When suppliers must increase prices, don’t feel like you have to stay with them. Using several suppliers can help you lessen the impact of a sudden price hike from one, and ensure more stable costs. When you work with multiple suppliers, you’ll also gain negotiation leverage if one becomes too expensive. Either they work within your budget, or you can go to another existing supplier to meet your needs. Supply chain issues are a common side effect of high inflation, so diversifying your suppliers doesn’t put your proverbial eggs in one basket.
4 Lean into your best products and customers
Whether you operate a small grocery, sell medical supplies, or you’re a children’s birthday party performer, most businesses offer more than one product or experience. During periods of inflation, it’s crucial to focus on your best customer experiences and most popular products.
If you have to increase prices, mark up less popular products before you raise prices on the most popular ones. If you do raise prices on the most popular products, make sure they aren’t so steep and sudden that they turn customers off. Likewise, service businesses should focus on training staff on how to deliver even better customer experiences.
This is another application of conscientious financial management, as understanding your best products and most loyal customers will require some analysis. When you have to make sacrifices, cut products that have small profit margins or tend to be purchased in smaller amounts.
5 Invest in technology
It may sound backward to spend more money when you’re dealing with small business inflation, but technology can help improve efficiency and reduce costs in the long run. There’s no shortage of technology on the market today, so whether you’re looking to improve inventory management, identify marketing opportunities, increase productivity, or something else, you’ll have multiple tools to choose from. Finding technology that fits your business and supports streamlining your entire business model can help your small business operate more smoothly and avoid some painful decisions.
Conclusion
Inflation tends to have a stronger impact on small businesses than it does on large ones. As high prices lead to a domino effect of consequences throughout a business, it can be challenging to figure out how to stay afloat during periods of high inflation. However, with the strategies outlined here, along with robust financial management, your small business can navigate inflation successfully.
FAQs
Inflation is the increase of the price of goods and services over time, which reduces both consumer and business purchasing power. Inflation is unavoidable and natural in a healthy economy. Periods of high inflation, however, can have many negative impacts on small businesses, from increasing overhead and production costs to disrupting supply lines.
The best way to prepare for inflation is with contingency planning. Smart business owners know that economic downturns, slow business periods, or inflation spikes are bound to happen from time to time. Setting aside cash reserves and developing financial management plans for periods of high inflation will help small business owners navigate the challenges that arise from inflation spikes.
Small businesses navigate inflation in a variety of ways. Most of these strategies are underscored by strict financial discipline and budgeting. Some of the most common include cutting costs, raising product prices, diversifying supply chains, and investing in innovations to your business model.
