How Does Inflation Affect Small Businesses?

What is Inflation?

Inflation is the economic phenomenon of prices increasing over a given period of time. It can be as general as an increase in the overall cost of living or as specific as the pricing on individual goods and services.

Like everything else, inflation has both upsides and downsides. The Federal Reserve has determined that an annual inflation rate of 2% is just high enough to prevent weakening the economy. If inflation is too steep, however, consumers start to buy less. Increased prices with stagnant wages mean consumers likely have less money to spend on nonessential goods and services.

Inflation and Small Businesses

With the price of materials on the rise and consumers buying less, small businesses are feeling the heat. According to a survey conducted by the National Federation of Independent Business, 56% of small business owners reported that inflation has had a substantial impact on their business, while 35% reported being moderately affected.

Those surveyed reported that some of the highest contributing factors to higher costs are the costs of fuel, inventory, materials, and supplies. As a result, the majority of small business owners stated that these overhead cost increases have resulted in their increasing the cost of services and goods.

The cost of goods and services

Between the COVID-19 pandemic and worker shortages, many supply chains have taken a hit. Goods and materials have become more difficult to obtain, causing prices to skyrocket.

While trends indicate that supply chain issues are gradually beginning to ease, small businesses are still feeling the strain those issues have caused in recent years. Shortages of materials and inventory were major obstacles for small business owners who were struggling to secure their usual stock.

Because many goods were scarce, their costs increased. CNBC reports that wholesaler prices have increased 11.2%.

Cost increases on necessary materials forced many small businesses to raise prices on the goods and services they provide. And these price hikes did little to benefit the businesses. Despite 71% of small business owners increasing their prices in recent months, 82% report lowered business earnings.

The cost of capital

Every small business needs to refresh and revamp the way it operates. These updates often require capital investments. When your small business finds an investor, the investor expects their capital contribution to be used to maximize the financial return — that return is referred to as the cost of capital.

With prices on the rise and consumers becoming more budget-conscious, money is not going as far as it once did. Small businesses may struggle to achieve the return on investment that their investors expected.

The borrowing costs

Whether you’re trying to start a business or offset some of the financial losses caused by the bottlenecked supply chains, your small business may need financial assistance from a lender.

The good news is that business loan approval rates are consistently increasing. The bad news is that interest rates are increasing, too. Small business owners seeking funding will be faced with inflated interest rates, while struggling to maintain profitability.

How to Manage Inflation as a Small Business Owner

Navigating the obstacles caused by inflation as a small business owner may seem like fighting an uphill battle. Between struggling to keep materials and products in stock and consumers consciously trying to spend less, keeping your business afloat — and ideally, thriving — is a challenge.

Rethinking your approach can help keep your business on track. Here are three strategies to consider for guarding your small business against inflation.

Review your business model

A practical first step for combating inflation is to get a good idea of where your money is going and whether there are any areas where costs can be trimmed down.

The Harvard Business Review recommends getting spending visibility. Make sure it’s broken down into categories that clearly illustrate which parts of your business the money is going to. Doing so may illuminate which business units and cost categories are hitting your wallet the hardest.

Think strategically. Look for ways to minimize the spending that could increase your profits, or consider more strategic spending that will protect your employees and clientele. This may mean investing in employee education or a commitment to the highest-quality customer experience. Doing so shows that you value your employees and customers, and ultimately will help set your small business apart from its competitors.

Stay up to date on trends

Keep an eye on the rising cost of necessities. The rising price of fuel and materials, as well as rising interest rates, could impact your operational costs significantly, so it’s best to stay on top of those expenses. By learning more about inflation, small business owners can negate overhead increases from the effects of inflation on small business. The sooner you can adjust your spending to accommodate the changes from inflation the sooner you can overcome rising costs.

One recent development is the Inflation Reduction Act that was signed into law. It’s unclear whether it will reduce inflation, but the Act essentially boils down into three basic parts.

The first is that it plans to reduce the federal deficit — which is how much the government spends in a year that exceeds the revenues it receives from taxes and other fees — which should help with price increases.

Second, it aims to promote the production of specific goods, primarily relating to renewable energy. The idea is that having more supply than demand will save money in the long run.

The third part will allow Medicare to negotiate with pharmaceutical companies, in an effort to cap the rising cost of needed prescription drugs for Medicare recipients.

While NPR advises that inflation won’t grind to a halt or be changed drastically, it may relieve some of the pressure on consumers. With less of their money tied up in inflation and healthcare costs <span style='color:rgb(0, 0, 0);font-family:"undefined";font-size: undefined;'>—</span> and more in their pockets <span style='color:rgb(0, 0, 0);font-family:"undefined";font-size: undefined;'>—</span> consumers may not have to budget so strictly.

Protect your profit margins

Prices may be going up, but that doesn’t mean your profits will go up with them. Increased costs can result in tighter profit margins. Make sure to prioritize maintaining the value you offer to your customers without taking a major financial loss.

It may sound drastic, but this may involve eliminating work. You could, for example, reduce the number of services you offer or limit the products you sell. Trim down your menu. Not only does taking something off your plate cut back on costs — it also may allow you and your team to give more attention to your most popular and profitable services.

Automating basic processes could also save you and your employees time, allowing you to focus on bigger undertakings.

Streamlining your offerings and simplifying your processes can help reduce your overhead costs without transferring too much of the inflation to your customers via price increases.

Protecting Your Business

When running a small business, value is essential. This is why Simply Business works with leading national insurers to find affordable rates for the coverage you need. General liability policies start as low as $19.58/mo.*

Conclusion: Inflation Impact on Small Business Strategies

As a small business owner, it can be difficult to navigate economic upsets. Although small business inflation concerns are nothing new, periods of accelerated inflation can put an undue strain on consumers and businesses alike. But there are steps you can take to soften the blow of price hikes and protect your small business.

Start with the basics by trying to reduce your overhead spending. Beyond that, consider making adjustments to your business model and work toward preserving your profit margin.

It’s important to manage your expectations — your efforts may take time to pay off, and the return may end up being modest. But keeping your business afloat and stable should be your first priority. With some creativity and quick thinking, you can help guard your small business against the impact of inflation and lay the groundwork for years of growth.

*Monthly payment calculations (i) do not include initial premium down payment and (ii) may vary by state, insurance provider, and nature of your business. Averages based on January - March 2023 data of 10% of our total policies sold.