It is no doubt that inflation is coming. In fact, some inflation is already here. Gas prices are up, food prices are up, and other prices have risen due to demand. How will gas prices affect everything that needs to be shipped? Are you prepared for the price increases? Will these price increases affect your business?
We suggest the following:
- Develop a Cash Flow Management Model
- Add extra costs into specific areas. See how these costs affect your Gross Profit Margin.
- Perform a Profit & Loss Analysis for April. Do one each month during this inflation period.
- Know the trends. How are others handling increased costs?
Inflation may impact your business in many ways. Customer pricing, shipping costs, supply chain pricing and other areas. Employees may feel the pinch and seek compensation for travel. Healthcare costs may rise due to the Covid-19 pandemic. This puts pressure on your business.
Consider what one expert said recently (May 3, 2021) in an interview:
“I think we will see price pressure this year. You’ve got a very strong demand situation, and you’ve got constraints in supply,” the central bank official said during a “Closing Bell” interview. “When those things happen, you’re definitely going to see price pressure.” – Thomas Barkin, President of Richmond Federal Reserve
Rapidly rising prices will cause consumers to spend less or be picky on where to spend. Larger companies may have a stronger cash reserve to offer deals or packages. Please consider having a plan (Inflation Plan) to reduce the chances of revenue loss.
Look at the following areas:
- Pricing (You Charge)
- Expense Reduction
- Overhead & Borrowing
We recommend that you develop an Inflation Plan. In fact, a Plan A and Plan B to help you adjust depending on the longevity of the inflation period.
SMALL BUSINESS BORROWING
During the early inflation cycle, many banks (and governments) actively expand their loan portfolio as cheap, easy money policies (of the government) place the economy into overdrive. This artificial “boom” generates many loans that are easy to get and affordable. These loans need to be used to increase efficiency and profits. Inflation can impact the benefits of these affordable loans.
Later in the inflation cycle, businesses may find it much harder to receive financing. Big Banks, lenders and other financial institutions will look closely at cash flow levels. With rising costs, they may want to ensure that the borrower will have the capacity to make monthly payments.
To protect themselves against the impact of inflation, lenders may increase interest rates to cover the cost of the depreciating value of the money. They will also hedge their risk due to increased market uncertainty.
- Build Cash Flow
- Reduce Costs
- Eliminate Waste
- Analyze Pricing
- Build Corporate Credit
Will you be able to retain your borrowing power? Will lenders become more cautious in 2021 and 2022?
CASH FLOW MANAGEMENT
Do you know the term “cash is king”? Well, it is! Cash flow is one of the most critical components of operational success for a small business. Without cash, profits can become meaningless. Some small businesses are profitable on paper and forced into expensive financing to survive. Soon many face bankruptcy.
Manage Cash Flow to avoid this. Know your trends. Where has your business been trending? Do you know your financial ratios such as Gross Profit Margin, Cost of Good Sold Ratio, Liquidity Ratios, Profitability Ratios, etc.
Liquidity Ratio Analysis
The first type of financial ratio analysis is the Liquidity Ratio. The liquidity ratio aim is to determine the ability of a business to meet its financial obligations during the short-term and to maintain its short-term debt paying ability. Liquidity ratio can be calculated by multiple ways they are as follows: –
The Current ratio is referred to as a working capital ratio or banker’s ratio. The current ratio expresses the relationship of a current asset to current liabilities.
Current Ratio Formula = Current Assets / Current Liability
A company’s current ratio can be compared with the past current ratio; this will help to determine if the current ratio is high or low at this period. The ratio of 1 is ideal that is current assets are twice a current liability, then no issue will be in repaying liability, and if the ratio is less than 2, repayment of liability will be difficult and work effects.
The current ratio is generally used to evaluate an enterprise’s overall short-term solvency or liquidity position, but many times it is desirable to know the more immediate position or instant debt paying ability of a firm than that indicated by the current ratio for this acid test financial ratio is used. It is relating the most liquid assets to current liabilities.
Acid Test Formula = (Current Assets -Inventory)/ (Current Liability)
The quick ratio can be written as: –
Quick Ratio Formula = Quick Assets / Current Liabilities
Quick Ratio Formula = Quick Assets / Quick Liabilities
Absolute Liquidity Ratio:
Absolute Liquidity helps to calculate actual liquidity, and for that, inventory and receivables are excluded from current assets. For a better view of liquidity, some assets are excluded that may not represent current cash flow. Ideally, the ratio should be 1:2.
Absolute Liquidity = Cash + Marketable Securities + Net Receivable and Debtors
The Cash ratio is useful for a company that is undergoing is financial trouble.
Cash Ratio Formula = Cash + Marketable Securities / Current Liability
If the ratio is high, then it reflects the underutilization of resources, and if the ratio is low, then it can lead to a problem in repayment of bills.
Debtors or Receivable Turnover Ratio:
The receivable turnover ratio shows how many times the receivable was turned into cash during the period.
Receivable Turnover Ratio Formula = Net Credit Sales / Average Accounts Receivable