Inflation has become a ubiquitous term, dominating conversations as rates ascend, particularly impacting our small business community. Escalating supply costs, a workforce scarcity, and dwindling profits are formidable challenges being confronted.
At its core, inflation denotes the increase in the cost of goods and services. Whether it’s a basic commodity or a substantial property, prices gradually climb. This fluctuation is influenced by various factors, encompassing supply and demand dynamics, production costs, workforce shortages, monetary expansion, and wage hikes.
Contrary to intuition, a certain level of inflation is deliberate. Economists widely agree that a 2% annual inflation rate is optimal, achieving equilibrium in the economy while fostering growth. This modest rate allows central banks to reduce interest rates, invigorating the economy without excessively burdening consumers.
Despite this consensus, the intricacies of inflation and its consequences spark animated discussions. While individuals cannot control inflation, comprehending its implications for personal finances is imperative.
How Inflation Impacts Small Businesses:
Small businesses, with limited financial reserves, are particularly vulnerable to inflation. As the cost of goods and services escalates, small enterprises must grapple with heightened expenses while having fewer resources at their disposal. Imagine a scenario where a small business sells a product for £10, and suddenly production costs surge to £12 due to inflation. The business faces a challenging decision – absorb the additional cost or pass it on to customers, potentially jeopardising sales.
A pivotal aspect of inflation is the erosion of consumers’ purchasing power. When savings grow at a slower rate than inflation, individuals effectively lose money. To preserve the value of savings, the interest earned must outpace the inflation rate. Presently, with global inflation surpassing average savings account interest rates, maintaining the same dollar amount may not stretch as far as it once did.
Navigating with the Rule of 72:
To approximate the impact of diminishing buying power, the Rule of 72 provides a useful tool. While a rough estimate, it helps visualise potential outcomes if current rates persist. To estimate how long it takes for savings to double, divide 72 by the annual interest rate. For instance, with a 2.5% interest rate, it would take around 28.8 years for savings to reach £200.
This rule also aids in understanding how swiftly inflation may erode savings. Divide 72 by the annual inflation rate. With a 6.5% inflation rate, it takes just over 11 years for £100 to halve in value.
This illustrates the challenge when the inflation rate exceeds the interest rate earned by consumers. As prices rise, consumer reluctance to purchase goods and services grows. If small businesses need to raise prices to cope with inflation, it could further impact consumer purchasing power. Consequently, small businesses must adapt to inflation to sustain their operations.
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The Team at London Accountants