How The Inflation Rate Impacts Business

While the rising inflation rate dominates headlines right around the nation, what does this figure and its domino effects mean for small business owners? 

Like it or not, the inflation rate influences almost every aspect of our day to day lives. From lettuce tripling in price to skyrocketing interest rates to raising the minimum wage, it’s evident that the Federal Government is weighing up its options with how to best navigate this economic conundrum. 

In its simplest form, inflation measures how much more expensive a set of goods and services has become over a certain period of time, and is usually measured over the course of one year. To measure the average consumer’s cost of living - and therefore the current rate of inflation - government agencies will usually conduct household surveys to identify a basket of commonly purchased items and track their cost over time, such as the price of rent, a mortgage, and even a loaf of bread. 

While we all know that the cost of living is currently through the roof, inflation seems to be a figure often thrown around that not many many people fully understand. When measuring its current and future impact on small business, it’s important to have a grasp on what influences inflation, and what measures are currently being taken to lower it. 

Understanding How Inflation Works In Australia 

Inflation calculated by the Australian Bureau Of Statistics, which collects prices for thousands of these types of household items. These figures then collate into the Consumer Price Index (CPI). The percentage change in the CPI over a certain period is consumer price inflation, the most widely used measure of inflation. As an example, if the base year CPI is 100, and the current CPI is 110, then the inflation rate is 10% over the period. 

In Australia, the annual CPI inflation increased to 5.1% in the most recent March quarter, due to higher dwelling construction costs and automotive fuel prices. What’s worse, is that the Reserve Bank of Australia is predicting that inflation will hit 7% by Christmas - but what does this all mean for small business operators?

According to the RBA, temporary changes in inflation may be caused by events like supply disruptions or seasonal sales. Like many nations, Australia is still playing catch up with lingering supply chain issues brought on by the pandemic, as well as dealing with the fallout from the year’s recent batch of wild weather. Needless to say, the conflict in Ukraine is also having a significant impact on wheat production and freight around the world. 

Comparatively, persistent changes in inflation arise from things like a sustained increase in wage growth across the community. When setting the cash rate, the RBA measures both temporary changes and persistent changes in inflation to “strike the balance” between short term and long term influencing factors to the economy. 

Since the early 1990s, the Reserve Bank of Australia has set the ideal target range of inflation between 2-3% with the end goal being to maintain price stability and full employment.

If the inflation rate is too low, consumers may delay purchases if they expect prices to fall. As a result, falling prices - a situation called ‘deflation’ - can lead to lower spending, and have a negative impact on the economy. Businesses often respond by laying off workers or reducing wages which, in turn places further downward pressure on demand and prices.

In contrast, the purchasing power of consumers - or the real value of money - is reduced when inflation is too high. If prices are increasing faster than the nominal incomes of consumers, they will be able to afford fewer goods and services over time. As a result, workers may seek larger wage increases to compensate for the cost of living, which can raise operating costs for business owners and reduce the number of workers they employ. As we are also seeing right around the world, high inflation also means that returns on investment may be lower. Inflation influences investment decisions, as higher inflation rates will reduce the real return on the investment. Inflation can also affect the real interest paid by borrowers to lenders. As an example, if inflation turns out to be higher than expected when the loan was agreed, the lender will get less than they had planned because inflation reduces the purchasing power of the interest earnings they receive.

Inflation often begins with a shortage of service or product, leading to businesses increasing their prices and overall costs of the product. This upward price adjustment triggers a cycle of rising costs, in the process making it harder for businesses to reach their margins and profitability over time.

From increasing the cash rate, implementing the temporary fuel excise, issuing price caps to the suspension of electricity trading and even triggering an increase to minimum wage, it would appear that the relevant government bodies are doing all that they can to stabilize the economy and shield Australia from the negative effects of a high inflation rate.

While it’s worth noting that we’re not the only ones suffering through such economic conditions, now is the time to partner with a strategic advisor to take control of your financial future as a business owner - and this is where the team at Muro can help. 

Take Control Of Your Financial Future With Muro

Whether you’re starting a business, purchasing an existing one, or even reevaluating where your current enterprise stands - all require some form of financial know-how if you hope to successfully navigate your legal tax requirements as well as hitting your financial and business goals. 

However, if understanding the legalities that surround your business or finances isn’t your strong point, then it may be reassuring to know that you’re not alone. In fact, many businesses (big and small) enlist the services of an accountant in order to free up their time while knowing that their financial obligations are already taken care of by the professionals. 

Ultimately, the team at Muro believe that every business owner is an entrepreneur. However, accounting does not discriminate - finances break down barriers and are not territorial. If you would like to take a deeper look into your finances, please get in touch with us at Muro today to ensure that you’re on the right path for success.