How Business Owners Beat Inflation: The Beginner's Guide
- October 7, 2022
- Posted by: Aitro3
- Category: CFO Advisory
Author: Jonathan Smith, ACMA – founder and MD of Aiteo Consulting
Jonathan was a senior Finance executive in the largest banks and financial companies in the UK. He oversaw annual cost spend of up to £1.5bn and successfully eliminated over 10% of recurring costs through transformation programmes. The techniques he deployed can work in any business, whatever the size.
In this briefing I’m going to show how business owners can beat the effects of inflation in their businesses and stay ahead of the competition.
Inflation levels we are seeing today haven’t been seen for over 30 years. The government’s response to the recent pandemic involved issuing war-time levels of new money into the money supply. And on top of that the economy is dealing with additional economic stress caused by a regional conflict with global risks. So we are seeing consumer price inflation (CPI) at the highest levels since 1990.
This price inflation is certainly going to feed through into the various cost drivers in your business. And if you don’t act to address it, your business profitability is going to suffer.
In this guide I’ll be showing you real immediate actions you can take to beat inflation.
what's the problem?
So what is inflation?
Stated simply, it is a measure of the increase in prices compared to a baseline period. As one example, we see energy costs impacted by a contraction in worldwide supply – and with supply down, prices are up, and anything that needs energy will cost more – which, ultimately, is just about everything.
But cost inflation might arise in places that aren’t immediately apparent. Do you operate through retail outlets? If so, it costs to keep the lights and heating running. And operating a heavy power-consuming outfit such as a small factory, or a garage, will mean these costs are going up, and so these product and service prices will have to be passed up the supply chain.
Energy is just one example. But given we can see price inflation across the board, what can you, as a business owner, do to beat it?
Here’s a simple process which you can apply across your business.
Step 1: Identify your drivers
Your first step is to identify the drivers of cost where inflation is really going to put on the pressure in your business. What kind of costs of yours are particularly susceptible to inflation?
For example, think of costs most directly impacted by energy prices – energy bills, transport, and consumables / materials (think what energy is required to produce those items before you buy them). And, if you’re in hospitality, core costs of foodstuffs will be a major cost driver too. As well as basic supply shortages, many foodstuffs are imported into the UK, so if the pound is weakening, your costs may well be increasing.
And it’s not just food – check any services where you’re not billed in GBP. You will have cost pressure due to exchange rate movements if the pound is falling in value against your trading currency.
Then, your staff will want to cover their increasing costs of living – so expect pressure to put up pay. And any costs you incur that require ‘knowledge’ input – lawyers, accountants, business advisors – will be under pressure too. And while you may decide to address this by keeping those overall budgets at existing levels, you will get less punch for your pound as costs per hour increase.
In a time of high inflation, interest rates are likely to increase too. Depending upon your capital and funding structure, you may see interest costs increasing if you are subject to variable interest charges – including on asset purchases.
You should identify any other cost drivers too. Think about subscription services you use – technology services, for example – as these are likely to have CPI or RPI increases in their contracts. Perhaps even your rental contract(s) have built-in escalators. Check out what you’re exposed to.
Step 2: Forecast the impact
Once you’ve identified the key areas where price inflation is going to put pressure on your cost base, you need to work out the impact.
First you’ll have known changes. Your contract reviews, for example, will identify guaranteed price rises, and you can estimate the impact out to future years too. You may have decided on some salary increases. If you have, don’t forget the impact on ‘on-costs’ such as employment taxes, bonuses … and so on.
But then, some items will be less certain. You will need to estimate out the impact of your core drivers (let’s say, energy) on your energy-sensitive costs. You may need to make assumptions, but you should give it your best shot.
At this stage, don’t figure out what cost-cutting or other mitigating measures you can take, because the impacts of inflation, and the mitigation strategies to address it, often get mixed up in peoples’ minds, and leads to confusion between impacts that are baked in already (so costs that will increase if you do nothing) versus mitigating strategies which at this stage are simply an aspiration (so actions that won’t happen unless you actively do something). Make sure these two remain separated out.
Step 3: Do your scenarios
Now you’ve got a forecast, you can start working on some scenarios. What if your main assumptions are incorrect? You might not know exactly how things will turn out, but you’ll know a range. So work out some scenarios – for example, worst case, best case and most likely mid case.
And after you’ve done all of that, make provision for any ‘unknown unknowns’. How much of a further cost impact could your business stand before you go below break-even? Or how much cost inflation would lead you to run out of cash in the next 12 weeks? 6 months? 1 year? Try some reasonable and unreasonable unknowns. After all, if every risk was reasonable, you wouldn’t be doing this exercise right now.
Your scenario planning should also take into account the wider macro-economic perspective – things definitely outside your control. Think about interest rates, foreign exchange rates, and any other major impacts on your customer base or supply chain.
Step 4. Mitigating strategies
Once you have a clear picture of the impacts of inflation upon your business and some scenarios to support this, you can work through some mitigating strategies. You need to think both strategically – for the long term, addressing fundamentals – and tactically, looking at rapid and effective actions for the next three to 12 months.
Overall, you need to drive efficiency, so start with you key drivers of cost and identify how they feed through your own supply chain. Here are some examples:
Assess your tech stack:
Take as an example a service business that relies upon a technology stack to deliver its own service. Look at the platforms that you use and you will almost certainly be able to identify overlapping features – so you are paying for a service twice – or you could identify a third vendor who could do it all for less.
Review your contracts
Get into the details of all your key contracts. Iron out the ‘no-value’ price increases (RPI / CPI) and check against the current indicators. Renegotiate.
Invest in new tech.
This is ‘strategic’. Can you invest in technology and process to help drive out high recurring operating costs? How quickly might benefits (=overall cost savings) come online? It could be quicker than you think.
Quid pro quo your wage increases
Your staff want wage increases- so if you need to do this, use the opportunity to link the increases to productivity measures and performance. Make sure you get a return for your investment. How will your staff do better?
Develop a cost reduction mindset
This can be both ‘strategic’ and ‘tactical’. Develop a cost awareness culture in your business. Get people involved and motivated to save money (see above – incentivise!). Sweat the small stuff.
Take your top (say 5-10) processes which are essential to deliver your overall customer service or product. Do these work as efficiently as they can? Can you squeeze time and cost reductions out which, even if small, will aggregate up into larger wins?
Are you still using an expensive overdraft when a consolidated loan will do? Are your terms the best you can achieve in the market? Renegotiate and consolidate.
Hedge your exposure
If your costs are influenced by exchange rate movements, do you understand how? Do you have forecasts and scenarios to show how exposed you are? And if you are exposed, do you have hedging strategies in place, and are they the best value?
Lastly, and very importantly…
During a strategic cost review, don’t forget the other important driver of your profit – price!
Look at strategic price increases during this time – all the while bearing in mind your customers will apply the same rigour to your price increases as you do to those of your suppliers. This means you should understand the relative profit of your various products or services – so you can figure out where are the price rises particularly needed. Make sure you make those changes if your market can stand it, because if you don’t do it this year, you will lose the narrative – it will be far more difficult to make price increases in the following year if inflation falls back.
And as you go on, keep the lens on inflation – continue to monitor, checking, re-prioritise and re-forecast.
So what now?
Thanks to this guide, you have the building blocks you need to get started beating inflation in your business.
Doing nothing is not an option. Inflation is likely to top out at over 10%. And in many businesses, a 10% narrowing of your profit jaws means saying goodbye to the return for shareholders – you, in other words.
If you think all of the above this is great, but don’t have the bandwidth, the time, the inclination or the skillset – this is where we come in. Our CFO service can work with you to beat inflation out of your business. Here are some of the ways we help:
- Inflation cost driver analysis
- Driver-based forecasting
- Scenario planning
- Identifying mitigating strategies
- Review your supply chain
- Cost reduction mindset
- Exchange rate modelling
- Pricing analysis and strategy
- Monitoring and improving your forecasting capability
And importantly, you don’t need to switch accountants. Our CFO advisory service works in lockstep with your existing service provider.