How Does Inflation Affect Businesses?

To prepare for inflation, business leaders first need to know how it might be affecting their business.
The definition of inflation highlighted in pink

In high inflation environments, the topic fills the news, social media posts, and office conversations. As consumers, this price increase in goods and services can be felt in our day-to-day lives – where a quick trip to the grocery store has exceeded our previous budgets. But what about businesses? How exactly are organization’s impacted by inflation? This is an essential question that business owners need to be able to answer to mitigate against the effects of inflation.

How Does Inflation Affect Businesses?

Increased Material Costs

One of the more direct consequences for businesses is the increased costs of the materials required to produce products and services. Along with this comes the potential for decreased margins. When referencing increases in raw material prices, most people’s first thought goes to manufacturers and product-based businesses; while product manufacturers may experience some of the most obvious effects, it’s important to note that service-based businesses can also experience the effects of inflation.

Increased Pricing

We know that inflation can increase the costs of raw materials and lead to decreased profits. In order to maintain profits, businesses often respond by passing inflation along to their consumers and raising prices of their own. What’s fascinating about this increase of prices is that, for many businesses, this results in decreased demand, which can then lead to a cycle of “cost-push inflation.” This type of inflation is often described as a “spiral” that can lead to even more inflation. 

Decreased Demand

Reduced consumer spending is a result of inflation that all businesses should consider.  When prices increase, consumers tend to buy fewer nonessential goods and services. The key word there is nonessential. Some businesses are impacted by inflation more than others, and companies that provide essential goods or services (e.g., natural gas, mail delivery services, utilities, and other necessities) don’t experience much decrease in demand from inflation. On the other hand, nonessential goods and services can see significant decreases in demand. As consumers lose purchasing power, they become more careful with their spending and cut out nonessentials. Businesses need to be proactive by understanding the degree to which their products and services will be affected.

Increased Interest Rates

The Federal Reserve, often referred to as “The Fed,” has a few different tools they use to fight extended inflationary periods, and interest rates are the most utilized among these tools. The Fed increases interest rates in order to bring down inflation; this works by increasing the cost of borrowing for individuals, and ultimately, decreasing demand. However, the cost of borrowing also increases for business, which affects a firm’s working capital and day-to-day operations.  

Where to Begin?

Curious about how to begin preparing your business for inflation? The first step is always to evaluate how your firm will be affected. Remember that all businesses are affected differently; your company’s size, industry, type of products or services sold, and numerous other factors all determine the repercussions of rising prices. These factors, as well as keeping up with current economic news and trends, are great starting points to combating inflation.

To help Indianapolis business leaders better understand how to protect their organizations from inflation, maximize resources in the current economic environment, and plan for the future, Blackink IT hosted our “Inflation-Proof Your Business” event on August 3of 2022. Read or watch our recap of the event here!

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