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Inflation is likely to be at the top of many businesses list of concerns, and if it isn’t it probably should be.

What’s driving inflation?

Restricted labour market. – There is a restricted supply of labour to the UK economy. This has been exacerbated by Covid-19 and the direct loss of workers in specific industries during the lockdowns.  Demand for certain skilled and unskilled labour is outstripping supply and driving wage inflation which will flow down to all businesses.

Supply chain disruption. – Covid-19 and geopolitical issues have disrupted supply chains in many ways and this restricted supply is driving up input costs for businesses

Limited supply versus demand. – The above have the effect of limiting supply of some goods and services at a time when demand is returning, driving up prices

Underinvestment. – COVID-19 and Brexit uncertainty reduced capital investment, this has likely had significant impact on capacity as fixed assets and infrastructure have degraded and not been replaced, reducing capacity and productivity in some sectors.

Shifting behaviours and demand patterns. – shifting demand patterns have left skills gaps in the labour market – for example the demand for retail staff has dropped but the demand for drivers has increased, however the capacity to retrain these employees in the short term is limited.  Many businesses and sectors which have seen record demand during Covid-19 are struggling to recruit skilled employees as demand for those specific skills has increased.

Critical bottlenecks. – All of the above and other factors are creating industry critical bottlenecks which can exacerbate supply versus demand issues and lead to exponential cost/price increases (e.g. UK energy market, transport, food processing)

Is inflation transitory?

The big question is whether current inflation is transitory or structural, this will be a big driver of how the Bank of England responds and what happens to interest rates.  At the moment the general belief is that it is transitory, however in truth we don’t know that for certain.  What the Bank of England does with interest rates on the back of inflation is a big unknown.

The odds are that a constrained labour market and import and export controls will mean, at least in some part, a sustained transition to a higher cost of living in the UK. This will move the UK more in line with the high cost of living economies such as Switzerland and Norway.

What does this mean for businesses owners?

Inflation in itself is not automatically good or a bad thing – it can depend on the specific circumstances of a business or individual.

Many people and businesses will not have any memory of how inflation can impact their decision making, given the low inflation, low interest rate environment of the last 20 years.  It is therefore all the more important that businesses start considering the potential impact of inflation and prepare themselves.

Inflation might be a good thing If you have high debt at a low, long term, fixed interest rate– if your income keeps pace with inflation then inflation will erode the value of your debt.  If you bought your first house in the 1970’s or 80’s then you likely benefited from this scenario.

Alternatively, if you are about to retire, then high inflation could have a negative impact on your post-retirement income.

Similarly, inflation will impact different businesses and sectors in different ways.  For example, inflation tends to be very bad for construction as it introduces volatility to costs and increased risk in pricing and demand.  Construction tends to slow dramatically under high inflation.  On the other hand, in the short term this may be a good thing for estate agents and house prices. While wage increases drive up property prices, this will also slow construction reduces the supply of new homes.

It is important that you consider your own individual, or your business’s, particular circumstances. Make sure to research the potential effects of inflation so you can plan and prepare.

Even if you think inflation is not having any immediate impact on you or your business eight now, if sustained, then the chances are it will have an impact on you at some point in the future.

Things to Consider:
  1. Look after your staff.

Given that a constrained labour market and wage inflation are the main drivers of the current inflationary environment, your top priority could be to ensure your staff are looked after. They should feel fulfilled and fairly rewarded to support employee retention and hiring.

  1. Understand your wage and labour costs.

Make sure you understand your costs versus market rates and trends.  Also, consider what skills your business needs and what the added value of those skills is.

  1. Analyse your expenses.

Analyse all your business expenses and how inflation may impact your operating costs.

  1. Review your pricing.

Look at the pricing and profitability of all of your services and products.

  1. Look at cash flow and forecasting.

Forecast your cash flow under different scenarios to understand the impact of inflation and pricing on your cash position and bottom line.

  1. Update your key risks.

Maintain a risk register highlighting key inflation driven risks to your business, cash flow and profitability.

  1. Eliminate unprofitable products or services.

Review underperforming product and service lines within your business. These can become an even bigger drain on your business in an inflationary environment.

  1. Review your financing.

Do you need to increase credit limits with banks and suppliers to account for inflation?  Do you need to refinance to longer term fixed or lower interest rates while interest rates are still low?

  1. Review your inventory management.

Will you have to reduce your inventory if costs increase to free up capital?   How might this impact costs e.g bulk discounts?  How does your inventory accounting impact your profitability.  Do you need to increase inventory to fix costs now and guarantee supply to your clients?

More to Consider:
  1. Speak to and negotiate with suppliers.

Understand what your suppliers are doing and what issues are impacting them.  Consider opportunities to renegotiate with them and fix in costs.

  1. Reduce bad debts.

Review your receivables and chase bad debts to limit the risk of economic uncertainty having a knock-on effect on your business.

  1. Look beyond just increasing prices.

Businesses should not just look at increasing prices: look at reducing material usage and tweaking or providing alternative products and services.  Consider the next time you buy a chocolate bar how food manufacturers have dealt with inflation by reducing size and weight of their products.

  1. How much cash do you need?

If you have large cash balances earning little or no interest, inflation will erode the value of that cash to your business, consider alternatives to reduce or invest excess cash balances.

  1. Invest in automation and productivity.

If your business has a high amount of labour costs then you should consider investing in technology and automation.  We believe wage inflation and higher labour costs are here to stay. So, the increased returns on technology investment may make it an even more attractive capital investment.  If your business is sitting on excess cash, is that cash better used investing in productivity to offset rising labour costs?

Review and Planning:
  1. Understand and look after your key clients.

Inflation introduces uncertainty. When there is uncertainty, it is even more important that you understand and retain your key clients. Make sure you understand how inflation may impact them.

  1. Review your fixed asset values, depreciation and replacement costs.

The replacement cost of your fixed assets is likely to increase. You should understand their current value and depreciation and how a replacement would affect your cash flow. Also, think about how you can cost effectively extend the life of your fixed assets and whether to replace ageing assets sooner.

  1. Review your capital planning.

Inflation and interest rates will impact returns on investment, does your capital planning take this into account?

  1. Review your tax position.

Understand your tax liabilities and their impact on cash flow.  Perhaps also consider how capital investment and tax credits can impact your business.  Consider how all of the above issues can impact your tax position.

  1. Plan for profit.

Profit growth does not just happen, it’s planned for. Having a flexible business plan that factors in these issues provides a course of action on the above will help the profitability of your business too. As we say at Bevan Buckland LLP, revenue is vanity, profit is sanity.

  1. Consider the impact of inflation on the value of your business.

If you are looking to exit your business at some point in the near future, then consider the impact of inflation on business valuations and your exit timing and strategy.

How We Can Help:

Inflation can impact your individual and business planning and decision making in many ways, the important thing is to be prepared. Bevan Buckland LLP can help you navigate all of the above issues.  Please contact your Bevan Buckland LLP advisor to discuss these issues further.

Bevan Buckland LLP is the largest independent accountancy firm in Wales, providing accountancy, tax compliance, audit, advisory, and other strategic services to small and medium-sized businesses across South Wales. Headquartered in Swansea, the practice has offices in Cowbridge, Carmarthen, Pembroke, Haverfordwest and St David’s.