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You know that feeling when you hear a particular word too many times and it starts to lose its meaning? Media across the board is touting “inflation” over and over again, but don’t let it go in one ear and out the other, especially if you’re a small business owner.
Inflation has a tangible impact on small businesses. As an entrepreneur, you’ll want to know contributing factors for the current record-high inflation, how it squeezes small businesses, and what you can do to stay resilient.
Where inflation stands in the US—and where it may be headed
Let’s shed some light on the environment small businesses must operate in by digging into what the current state of inflation really looks like:
By the numbers
There are multiple measurements for inflation that you can look at as a small business owner. To get a clear picture of where inflation stands, it’s best to consider different indexes together. This is because each one has its own upsides and criticisms.
For example, one of the more popular measurements is the Consumer Price Index (CPI). While helpful, critics are torn on whether CPI understates or overstates inflation.
Here are the four main inflation indexes in the US and what each one says about current inflation:
- Consumer Price Index (CPI): The cost of living for consumers is up 8.6% in the 12 months ending in May 2022, according to the CPI.
- Producer Price Index (PPI): Final demand prices, or the cost of producing goods and services, are up 10.8% in the 12 months ending in May 2022, according to the PPI.
- Employment Cost Index (ECI): Total labor costs increased 4.5% in the 12 months ending in March 2022, according to the ECI. Wages are failing to keep up with inflation, but higher compensation is still adding pressure to businesses.
- Gross Domestic Product (GDP) Deflator: The GDP Deflator, which measures the change in costs of goods and services produced within the US, increased 8.1% in the first quarter of 2022.
Contributing factors: The pandemic, war in Ukraine, and gas price surge
The U.S. government reserved a record $4.6 trillion for COVID-19 relief spending. More than $3.7 trillion has been spent, including funds for unemployment benefits, Paycheck Protection Program loans for small businesses and independent contractors, stimulus checks, and more. While helpful, this unprecedented outlay has created a ripe atmosphere for inflation.
Plus, the Federal Reserve (aka Fed) has employed a policy of slowing the pace of bond purchases, a process known as quantitative easing (QE). QE can propel inflation, though it also aims to foster economic growth. Without the intended economic growth, the US risks experiencing stagflation like it did in the 1970’s.
Small businesses are also feeling the ripple effect from Russia’s ongoing war in Ukraine. The war has squeezed a lot of supply chains across the globe, adding to existing shortages that started during the pandemic. Supply for commodities like oil, grain, metals, wood, and more have tightened dramatically amid the conflict.
Gas prices are surging in part due to the war, but consumers are bearing the brunt of it. In mid-June 2022, President Biden wrote a letter to US oil refinery companies telling them their profit margins are too high. He urged an increase in production to lower prices at the pump (the US average for regular gas was $4.968 per gallon on June 21).
However, Biden alone cannot enforce this. The controlling multinational organization, OPEC (Organization of the Petroleum Exporting Countries), and its allies are already struggling to reach production targets. Global oil production is poised to increase mildly in the coming quarters, potentially easing the burden on small businesses and consumers.
Expert forecasts for inflation
Economist at Harvard Kennedy School Jason Furman said inflation continues to pick up its monthly pace as of mid-June. Furman said at a Brookings event, “Some of that was very special factors, but some of it, like shelter, is much more persistent and likely to last.”
The Fed is trying to cut inflation down to 2%. However, Matthew Luzzetti, chief U.S. economist at Deutsche Bank, told the Associated Press in response to the Fed’s large interest rate hike in June, “It’s going to be a far bumpier ride to get inflation down than what they had anticipated previously.” Many experts fear a recession is looming.
Treasury secretary Janet Yellen reported that the Biden administration will increase its inflation outlook moving forward (up from a projected 4.7% for the year)
Pro tip: Consumers and small business owners, want to see how inflation will impact you personally? Check out the New York Times inflation calculator and take the quiz to see where you stand.
Where small businesses feel inflation
The data on inflation is striking, but what does it really mean for small businesses? Here’s where you’re likely to feel a squeeze:
Inflation leads to higher costs for goods and services, but it also contributes to complicated loan conditions.
Existing loans are “cheaper”: Interest rates tend to increase during times of high inflation. Because of this, your fixed interest rate on an existing loan will cost less in interest payments than if you borrowed now.
New loans will come with higher interest rates, but may be “cheaper” as time goes on: As inflation increases, the value of the money you’re paying back actually lowers. You’re not paying fewer dollars, but those dollars aren’t worth as much as they were at the start of the loan.
How inflation benefits business lenders: Higher inflation invites higher credit demand. This can result in increased interest rates.
The Fed is raising interest rates as part of an attempt to quell inflation. However, the Fed’s capacity to reduce inflation may be limited.
Pro tip: Prep a month or two out for rising interest rates on credit cards and new or variable rate loans. That’s how long it usually takes lenders to respond to a Fed rate hike.
The supply chain issues are twofold.
First, supply chain inflation is a beast all its own. Price increases for labor, energy, materials, and ingredients swell. As a result, the entire supply chain sees concentrated inflation.
Second, supply chain bottlenecks make existing inventory more valuable and make it harder for businesses and consumers to access supplies. Heightened demand mixed with lower supply is a recipe for a persistent supply chain squeeze.
A good example of this is real estate. In 2008, the housing bubble burst as a result of an excess of subprime mortgages, leaving about 23% of American mortgages with negative equity. Today’s housing boom is different—the demand is strong and there’s simply not enough supply to go around. The market is cooling, but slowly and with resistance.
Young Delaware company Henlopen Sea Salt, founded by former senator Dave Burris, searched for a property to cater to major demand for his popular local product for 18 months. “The holiday season was insane, with each of our sales selling out in minutes, leaving a whole lot of disappointed people,” Burris wrote. Finally, he settled on transitioning to a solar evaporation process so he could partner with a nearby farm and set up an outdoor production facility. A natural byproduct was his business shrunk its carbon footprint and energy costs by a landslide, but the difficulties getting there were undeniable.
Economic crises like recessions and record-high inflation tend to hit the people on the margins hardest. While wealthy individuals may not feel the impact, it can destabilize poor and working class families.
This is true for businesses too. Those whose bottom lines and cash flow are already squeezed are at greater risk of losing their profit margins. Small businesses are feeling the heat more than large corporations because bigger companies tend to pass costs along to consumers.
As inflation rages on, consumer behavior inevitably shifts. Small businesses face the reality of consumers adjusting their budgets to account for a higher cost of living. Spending growth on goods and services have declined mildly—but noticeably—from the start of the year, according to Barclays Research.
Sectors like retail, dining, travel, and more should expect to see a weakening, which may motivate business owners to diversify their offerings. In May, retail sales fell 0.3% in the US.
“Customers are saying, ‘I know it’s time to get a new roof, but can we get a little more time out of this one?’ They’re thinking about their budgets a lot more.” — Ben Noffke, president of Noffke Roofing
How US small business owners can adapt to inflation
The NFIB Optimism Index shows small business optimism at a 48-year low, but many small businesses are remaining resilient in the face of inflation.
So what can you do to stay resilient?
- Borrow wisely. Consider the cost of interest on a loan, but remember that borrowers have the upper hand during periods of high inflation.
- Plan your finances 3–6 months in advance. At times like this, preparation is key.
- Diversify your offerings: Tow the line between offering discretionary goods and services as well as consumer staples. Diversification is key as different industries experience different impacts.
- Prioritize business legitimacy. Find out your business credit score and, if necessary, work to improve it. You can do this by securing trade references, borrowing on behalf of your business, and making payments on at least a net-90 basis.
Last word on inflation and small business
From rising costs to supply chain disruptions, squeezed bottom lines and labor shortages (and everything in between), inflation is a beast. Despite it all, today’s small businesses are resilient. While today’s small business landscape may require more pivoting than you ever intended, building a business amid the impact of inflation has the potential to prepare you for the future.