Inflationary pressures hitting SME businesses
“In this world nothing can be said to be certain, except death and taxes”…. and inflation
Inflation is defined as a general increase in prices and fall in the purchasing value of money. In simple terms, it is how much more expensive things are going to get! The main word to highlight here is ‘general’. Often expressed at a percentage, it is a generic measure looking at the UK economy as a whole, not associated with certain sectors (e.g. building and manufacturing which are currently seeing huge cost base increases).
There are 2 main measures of inflation which you may have encountered known as Consumer Price Index (CPI) and Retail Price Index (RPI), both produced by the Office for National Statistics. CPI looks at the ‘basket of goods and services consumed by households’ – including food, fuel, housing, clothing whilst RPI also includes the likes of mortgage interest payments and council tax. CPI is the most commonly used index for inflation.
Inflation is generally controlled by the Bank of England. There are 2 main policies used to counteract inflation:
Monetary policy
Higher interest rates are introduced to reduce demand in the economy (it becomes more attractive to save and financing purchases becomes more expensive). This lower level of spending leads to lower economic growth and lower inflation. Interest rates were chopped at the start of Lockdown in 2020 to an all-time low in order to increase spending and help prop up the economy during lockdown.
On 4th November 2021, there was a vote by the Bank of England committee to keep interest rates at 0.1%. However, as things begin returning to normal (or the new normal), there is significant pressure of the Bank of England to increase interest rates in the coming months to counteract inflation, with expectations of increases to 0.25% by the end of 2021 and 0.75% over the next 18 months.
Fiscal Policy
Higher rates of tax are imposed (predominantly income tax and VAT) which reduces the level of disposable income for individuals and businesses alike. This leads to lower spending, lower demand and lower inflationary pressures. 2022 - 2023 is set to bring several upward increases to taxes on individuals and businesses alike to combat inflation and raise finance for the government.
The Past
The trend of inflation in the UK over the past 12 months:
Inflation (CPI %) throughout 2021
The trend of inflation in the UK over the past 25 years:
Inflation (adjusted measures %) over 25 year period
The Future
In theory, inflation is easy to predict and control. In reality, the likes of the 2008 Recession, COVID-19 pandemic and the current energy price crisis cause issues and massive fluctuations. The Government set a national target of 2% however as can be seen in the graphs above, this is hard to abide by.
The reality is nobody knows what will happen with inflation in the UK, however current forecasts look challenging. At the time of writing, the UK is sat at an inflation rate of 4.2% and potentially due to hit 5% by the end of 2021 (for reference CPI index has averaged 2.49% from 1989 until 2021).
Business Impact
So, what does this mean to you and your business?
At an operational level, products and services will become more expensive, meaning prices charged to customers will likely also have to increase to maintain profit levels.
Overheads (in particular wages) will also be a continuously rising cost although not necessarily with such a sharp increase. At a strategic level, it could impact the overall valuation of your business.
One way businesses are valued is using a so called ‘discount rate’. The impact will be that investors (banks, private equity etc.) need a higher return on their investment to counteract the impact of inflation. This in turn increases the ‘discount rate’ applicable to certain industries meaning overall valuations reduce.
What can you do?
As equipment and materials are only going to get more expensive, it may be worth making those necessary capital investments that have been put off. Don’t forget there are some good capital allowances available at the moment.
Be prepared! There is usually a lag between the cost of goods increasing and the same increases being passed onto customers. If you are prepared for this, the drop in profitability and cash can be kept to a minimum. Always have a back-up option available (e.g. an overdraft facility) as things will likely not go to plan
Review the cost base of the business and determine what non-strategic costs are being incurred that can potentially be reduced
If you feel finances may be tight, get in touch with us to help review funding arrangements.
Personal Impact
We have already seen drastic changes in the past months, with utility bills and fuel prices soaring. Holidays look to become more expensive as GBP weakens against other currencies (movement in exchange rates are partly determined by the rate of inflation in both countries). Nothing can be done to counteract inflation on a personal level, however there’s no reason we can’t be prepared for it:
Some people are taking advantage of the currently low interest rates; whether that be looking for a new car to finance or looking at re-mortgaging onto a fixed rate deal.
In the long term, people are looking to drive more efficiently and even live more efficiently (think electric vehicles, solar panels, new windows and smart heating).
A lot of conversations are being held between employers and employees about pay increases in line with inflation.
Others move savings/ spare cash into higher return opportunities (money in a bank making 0.3% actually loses value over time).
Review your tax position e.g. taking advantage of tax-free ISAs and pension contributions.
Most importantly, budget!
Seek expert advice – get in touch with us and we can recommend trusted advisors.
What can we do about it?
Whilst there’s nothing we can do to stop inflation, there are many ways BSN are able to help counteract the impact of inflation, whether that be personal finance/tax planning or business restructuring. Speak to us to find out more.
This article is for generic information only and should not be construed as advice. Please contact us before proceeding with any course of action.