Preparing for inflation

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Inflation has been on the rise since the pandemic began. With varying opinions on the potential duration of the current inflation surge, it is crucial to understand the causes and prepare. Inflation can dramatically reduce profits and harm companies. Let's start by looking at current signs of inflation, and then we will discuss what companies can do to prepare.

Current signs of inflation

Potential Causes of Inflation

  • Supply & Demand - One of the causes of recent inflation increases is supply and demand issues. Due to labor shortages and assumptions made in specific industries, low supply and high demand have caused prices to rise significantly.
    • For instance, in the lumber industry early on during the pandemic, most lumber mills expected a significant decrease in demand for their products. However, the opposite ended up being true. People were at home more often than usual and started doing a renovation or even building new homes. Once demand increased, the lumber mills quickly ramped up production and eventually got to the point where supply was higher than the demand, which caused prices to start coming back down. Although they have come down from the peak prices, they are still greater than pre-pandemic prices.

      One cause for the flip in supply and demand in this instance was demand going down due to the high prices individuals and businesses were paying. This suggests that as inflation increases, demand will go down, which will hopefully cause prices to start to fall. Another industry seeing similar price increases is the auto industry due to the chip shortage, which has also caused car prices to soar.
  • Labor Market - Another potential cause for the recent inflation the country has been seeing is the labor market. During the pandemic, unemployment increased significantly as employees were furloughed or even terminated from their job. Some individuals chose to leave the workforce to make the same money on unemployment as they were at their jobs. This has led to a tough labor market for employers, which forced many companies to raise wages to retain employees and hire new ones. These wage increases will typically be passed on to the consumer, causing an increase in prices. Due to increased wages, consumers have more money to spend on goods. As many feel prices will continue to rise, they are purchasing goods now to prepare for the expected higher future costs, which has caused further supply issues.
  • Supply Chain - The pandemic has caused several supply chain issues for the country. The previously mentioned supply and demand and labor market issues have also led to supply chain issues. Due to labor shortages, ports of entry to the country have not been operating at total capacity, leading to many ships being stuck off the coast waiting to unload goods. Labor shortages have also reduced the number of truckers available to ship goods throughout the country. Both of these issues have led to shortages on the shelves in several different industries. These shortages lead to increased prices, as stores can charge more for the few items they have on hand. Many fear that these supply chain bottlenecks may worsen, which could cause inflation to no longer be transitory.

Ways to Prepare for Inflation

  • Reevaluate Standard Costs & Overhead Rates – Most companies evaluate their standard costs and overhead rates annually. In times of high inflation, it may be best not to wait for year-end to assess these costs. Assessing them throughout the year will help avoid significant year-end adjustments and better reflect the current cost environment. This will help justify potential increases in prices to consumers during the year.

pricing case study

  • Improve Technology – In some industries, labor costs can potentially be reduced through automation. This is one way to save costs and hopefully increase profits. It may also help operate at a greater capacity, as currently, many companies are having a hard time finding the labor they need to work at total capacity. By implementing specific technology improvements, it may take fewer employees to get back up to full capacity.
  • Consider Borrowing or Restructuring Debt – In times of high inflation, the dollar's purchasing power drops quickly, which typically leads to lenders wanting to increase interest rates. As current interest rates are still historically low, now may be an excellent time to consider getting a loan for capital that may reduce costs or help to increase revenue. If the decision is made to get a loan, insist on a fixed interest loan instead of an adjustable-rate loan to ensure borrowing costs will remain constant regardless of future economic conditions. For debt already held, it may be worth trying to convert loans with an adjustable-rate to a fixed-rate loan if the lender will allow it.

These recommendations may not make sense in every situation, so it is essential to make informed decisions with a professional. Smith Schafer's experts can help companies prepare for the rigors ahead.

If you have any questions, please reach out to your Smith Schafer advisor, or click the button below to send us a message.

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