What does the high inflation rate mean for small businesses?

The UK is experiencing a high rate of inflation. What is inflation and how does it affect small businesses?

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Inflation measures how much prices for goods and services rise over time. When inflation is high, it means consumers can’t buy as much with their money.

What is inflation?

Inflation is a normal feature of the economy. In general, it encourages spending. If prices are expected to rise over time, consumers will buy goods now rather than wait.

But inflation can either be too low (meaning that consumers put off spending their money with businesses) or too high (meaning that businesses struggle to set prices as demand outstrips supply).

Why is inflation rising?

Inflation has been rising following the coronavirus pandemic and global lockdowns.

As economies opened up in 2021, people were able to spend their money again. Demand for certain goods and services increased, putting pressure on businesses and supply chains. This led to price rises.

What’s more, lots of people decided to change jobs following the pandemic. These shifts in the labour market have led to higher wages, increasing costs for businesses, which eventually get passed on to the consumer.

And in 2022, the war in Ukraine and subsequent sanctions on Russia have led to more pressure on fuel and food prices.

Many EU countries rely on Russia for their oil and gas. With imports banned, they have to source oil and gas from elsewhere, affecting supply.

How is inflation related to interest rates?

To combat rising inflation, the Bank of England may increase the country’s base interest rate. This makes it more costly to borrow money, encouraging consumers to save rather than spend.

Since the financial crisis, interest rates in the UK have been low, which in theory encourages spending and investment.

With inflation above nine per cent, the Bank of England has gradually raised interest rates over the last year. This can affect repayments on loans, notably mortgage repayments.

The Bank of England has a target rate of inflation – two per cent – which it hopes to reach by increasing interest rates. It says the target rate of inflation is there for stability, helping “everyone plan for the future”.

What is the current rate of inflation?

You can check the current rate of inflation at the Bank of England, which releases a monthly figure.

The rate of inflation measures how much prices have risen over the previous 12 months.

In the UK, the ONS measures inflation for everyday items by using the Consumer Prices Index (CPI). This tracks the prices of everyday items, known as the ‘basket of goods’.

The basket of goods is regularly kept updated with new items. Tinned beans and sports bras have been added in 2022, reflecting changing trends in diets and exercise.

The rising cost of gas, electricity, and fuel is heavily contributing to increasing inflation.

How does inflation affect businesses?

When prices rise, it doesn’t just affect consumers. As mentioned, wages increase as employees ask to be paid more to compensate for increasing inflation (or move jobs altogether).

Businesses are affected by supply pressures as they pay more to buy materials and products. They may have to wait longer until stock becomes available (and then face increased shipping costs and times).

Supply shortages for raw materials like timber can also impact prices. In 2021 we surveyed tradespeople to find out the impact of surging demand and labour shortages on costs.

You might have already experienced problems with your supply chain, as well as labour shortages if you’re looking for staff.

Consider these steps to tackle inflation:

Audit your prices. A fresh break even analysis could help you work out whether price increases can lead to a better profit margins. But don’t take this decision lightly, as customers may be used to current prices.

Audit your costs. Similarly, take a fresh look at your expenses to see if you can reduce them. Can you cut any inefficiencies? Lean manufacturing principles may help you find ‘waste’ in your current processes.

Come up with new plans and forecasts. As the world changes, your plans may need to change too. Take a look at your business plan to see whether there’s anything that needs updating. You can also create a new cash flow forecast and do a fresh budget.

The Bank of England thinks inflation will keep rising

While the Bank of England’s deputy governor previously said that “inflation may still prove temporary”, according to The Telegraph, the central bank now believes inflation will hit 11 per cent in 2022 before starting to fall in 2023.

Simply Business’s UK CEO, Alan Thomas, said in May 2022: “High inflation is squeezing small business owners while many are still in a crucial recovery period. The eye-watering cost of Covid-19 for SME owners, including lost work, earnings and loan repayments, now sits at a total of £109.6 billion according to one of our recent surveys.

“One in six also believe they will never recover financially from the pandemic. As a result, two in five (46%) SMEs are calling for long-lasting financial support from the government to help them get back on their feet after Covid-19.”

How is rising inflation affecting your business? Let us know in the comments below.

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