The Inflation Threat

(source: GMC)

Frank and Tom were baffled, how could it be that their bank account just wasn’t getting them through the month.

Revenues in their business F&T Plumbers reached new highs last year. Profits weren’t amazing but they weren’t terrible either. They had even managed to put some money aside.

Now, three months into the new year and cash is tight. The savings they accumulated last year are gone and Frank and Tom are wondering if they might need to loan the business money to make payroll next month.

How had things gotten so bad they wondered?

Tom decided to call an electrician friend of his named Jim who had mentioned a similar problem he was experiencing a year ago. Jim’s business is thriving now. Maybe he found a solution.

What Jim had to share wasn’t complicated, but it made all the difference in the world.

Last year Jim had decided to offer his staff a 5% wage increase. His small team was very experienced, they worked hard and delivered outstanding customer service to his clients.

Noticing that other companies had also been offering wage increases Jim was concerned he might lose one of his great team members to a competitor and wanted to be proactive.

The following month Jim received notice of a 7% price increase from one of his primary suppliers. Everything was getting more expensive. It wasn’t just the fuel for his trucks or the cost of insurance. What was Jim going to do?

Jim knew that he needed to respond quickly or the increased cost of doing business was going to overwhelm him. If the cost of his labour and materials increased and he didn’t respond right away that could only mean his profits would also shrink.

(source: Bank of Canada)

Jim knew that operating a sustainable business required him to spend money on fixed costs each month. Things like shop rent, administrative personnel, marketing and sales costs, not to mention what he paid himself as a management salary.

These costs would never go away, and since they needed to be paid from his gross profits which were shrinking he needed to respond immediately with price increases of his own.

Jim’s quick response was exactly what his business needed. His customers may not have been excited about a price increase but understood it was necessary.

In fact, only a few even commented. Sales continued to grow and margins remained strong. Jim’s staff were appreciative of the raise and continued to deliver amazing service to their clients.

Tom was inspired by Jim’s story and asked if he would speak with Frank as well so they could build a similar plan.

Why is inflation a threat to business?

Inflation causes the prices of the goods we purchase to increase reducing the purchasing power of the dollars we have available to spend. In normal times we anticipate a modest amount of inflation to occur, typically between 1% to 3%, however, as we have all experienced during the last few years, inflation rates have increased dramatically, peaking at 8.1% in early 2022.

Taking a look at the Bank of Canada’s Inflation Calculator the combined effect of inflation from 2019 to 2023 is 16.4%, which means it would take on average $116.40 to purchase what $100 could purchase in 2019.

Why is the inflation threat greater to small businesses than large businesses?

Small businesses are slow to respond

Most small businesses don’t have the same access to professional advisors that large businesses do. For example, most large businesses employ accounting professionals like a Chief Financial Officer (CFO) and accounting teams that report to them.

These accounting teams provide businesses with timely strategic information. This information is then used to analyze performance, study the market and consider the impact of competitors.

The outcome is that large businesses anticipate market conditions, and closely watch trends in their businesses keeping them agile and ready to respond in any event.

Small businesses on the other hand rarely seek guidance from accounting professionals apart from completing their taxes at year end, preparing payroll and filing sales tax returns.

These are all historical events that do nothing to prepare the business owner for what’s ahead.

This lack of preparedness leaves small businesses at a distinct disadvantage as they are forced to rely on gut instinct when responding to inflationary pressures. The gut instinct approach typically materializes as delayed price increases resulting in eroding margins.

Also, large businesses have deeper pockets, whether we’re talking about operating lines of credit, access to capital markets or simply cash in the bank, large businesses typically have more funding available to weather a storm than small businesses do.

To illustrate this point, imagine you’re driving through the Rocky Mountains. You’ve just passed a gas station and while you only have a quarter tank left you decided not to fill up because the price of fuel was high. So, you get back on the road and after a few minutes you pass by a sign that tells you the next gas station is 150 kms away. Too late.

Access to cash for a business is like fuel in the tank of a car. The less you have, the less prepared you will be in an emergency.

Think of inflation as that emergency, and the cash is the fuel in your tank. The more cash, or access to cash, that your business has, the longer you can operate in conditions that are not optimal.

If you have a large amount of cash and inflation is high you can operate for some time before your business begins to suffer, but if you only have a small amount of cash your response time must be very quick or the impact of inflation may be catastrophic.

Three things that will protect your business from Inflation!

1) Watch the trends – I recommend running a 12-month rolling average income statement paying close attention to gross profit trends. Service businesses have two distinct revenue sources, materials and labour, so it’s always best to calculate gross profit separately.

2) Be quick to respond – The clock starts ticking the moment your suppliers increase their prices and the moment you increase the wages of your staff. The faster you respond with price increases to your customers the less destructive the impacts of inflation will be on your business.

3) Hire a professional advisor – Large companies would never operate without their strategic advisor. Stop giving them the advantage. Hire an outsourced accounting team that can act as your strategic advisor, not a data entry clerk and a tax preparer.

Inflation is only a threat to the ill prepared. Make a plan and work your way through it. <>

Matthew Birch is the founder of Legacy Profit Sales an organization that connects premium bookkeeping firms with business owners searching for premium bookkeeping service. All firms in the Legacy network go through a 14-point pre-screening process to ensure that they have robust systems and procedures that will enable them to meet the high standards expected by our clients. He can be reached at Matthew@BirchAccounting.ca or 587-318-0391