Wherever you look, prices of gas, transportation, essential materials, products, and services are shooting up at rates unseen in over a decade. Large corporations have already become proactive, bracing for impact as stocks continue to plummet due to inflation and Fed rate hikes.
Is there a concrete method to prepare your organization for inflation?
First, let’s look at why inflation is so high, how inflation accounting can help, and finally, ways to restructure your cost analysis for inflation within your organization.
Why Inflation Is High
Rising prices at the gas pump and in grocery stores have been one problem, but inflation has spread beyond, to housing, car sales, and many other areas. The primary reason is that the nation still has not been able to keep up with consumer demand after COVID.
Supply chain interruptions, labor shortages, increase in shipping and insurance rates, along with China’s lockdowns have all negatively affected production lines for goods and services. Even though wages are rising, many companies are unable to retain employees. Take truck drivers, for example; there are 80,000 unfilled trucker vacancies in the US alone. Globally, the shortage is wider spread.
Another cause of high inflation has to do with Russia’s attack on Ukraine, which both directly and indirectly fuels inflation. Russia is an important manufacturer of natural resources like oil, coal and gas. In addition, Ukraine is one of the largest exporters of grains and fertilizers. Together the war-driven instability in these countries is enough to destabilize the global supply chain system for decades.
Despite global challenges, there are steps small businesses can take to help weather the storm and even come out ahead.
A great place to start tackling inflation is accounting for it correctly in your operations. Many companies take advantage of what is known as inflation accounting, which is when financial statements are adjusted according to price indexes rather than traditional cost accounting. These adjustments paint a clearer picture of a firm’s financial position during high inflationary periods.
Here are the two main methods used in inflation accounting:
1. Current Purchasing Power (CPP)
Under this cost method, monetary and nonmonetary items are separated. Monetary items are subject to the recording of a net gain or loss. Whereas nonmonetary items, or items that do not have a fixed value, are updated into figures with an inflation conversion factor related to the consumer price index (CPI).
2. Current Cost Accounting (CCA)
This approach values assets at their fair market value (FMV) rather than historical cost, and fixed assets are recorded at replacement cost value on the balance sheet. Additionally, depreciation of fixed assets is to be calculated at replacement value.
To calculate the inflation rate, divide the CPI at the end of the period by the CPI at the beginning of the period multiplied by 100.
By adopting inflation accounting, you can match your business revenues accurately compared to current costs to provide a more realistic profitability breakdown.
Comprehensive Cost Analysis
There are hundreds of inflation articles centered around businesses employing price increases. The reason is this tactic helps an organization in the short term. Even consumers might be on board with the higher prices, especially if they believe these are only temporary.
However, to overcome inflation in the long run, a company must look beyond price increases to reduce the financial volatility across the entire organization.
The beginning of an inflation crisis is a great time to get granular about your organizational costs. Don’t just look at the price your suppliers and competitors are charging, but perhaps create alerts to be notified of price fluctuations for raw materials and other supply chain data. Getting ahead of these increases will provide valuable information such as surfacing a supplier who is price gouging unnecessarily.
Another initial cost strategy is to understand your capital structure. Take a deep dive into your cash, credit, and debt to determine which loans need immediate repayment. Restructure your financial management by obtaining new lines of credit as a fallback in case situations last longer than anticipated.
Keep morale high to prevent employee attrition. The last thing your company needs right now is to lose its top talent to a competitor who is almost surely hiring. Losing employees could mean months of lost productivity and massive resource expenditure on identifying, hiring, and training replacements.
It may also be time to update your technology stack. Take a lesson from Tesla, which now utilizes robots and AI to construct and build electric vehicles. Start learning new applications like automating your HR and payroll, or integrate new software to help roll out digital marketing strategies.
Another cost-saving tool is to redesign products to reduce the impact of expensive materials. Go back to the drawing board to create innovative products that retain their quality without the dependence on finite resources.
Overall, inflation can present a valuable opportunity for many organizations to nail down their cost structure. Regardless of whether inflation is here to stay, companies that adapt their business operations quickly and decisively to rising costs will be in the best possible position to maintain margins and growth.
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