Making Decisions in Inflationary Times

May 03, 2022

INNOVATION AND DISRUPTION

Posted by CLA (CliftonLarsonAllen)

Key insights

  • The impacts of inflation are not the same for every organization, and successful decisions from past inflationary periods don’t necessarily translate in future inflationary times.
  • Develop a financial model and run various “what-if” scenarios to stress test your tolerance to inflation — and quantify the financial impact of decisions before you commit to them.
  • Consider three key areas: supply chain, labor, and pricing. As signs of continued significant inflation surface weekly, business leaders and business owners are making decisions to guard against shrinking profitability and to protect long-term viability. Are they the right decisions?

As signs of continued significant inflation surface weekly, business leaders and business owners are making decisions to guard against shrinking profitability and to protect long-term viability. Are they the right decisions?

Each inflationary period has its own distinct set of pressures. Successful decisions made during 2008’s inflationary period might not translate successfully to the next inflationary period. Even within the same inflationary period, the impacts on different organizations won’t be the same.

To actively guard against negative inflation impacts, assess and test three key areas: supply chain, labor, and pricing.

1. Supply chain

Supply chain strains and disruptions can be both a cause of and a result of inflation. Inflation impacts each organization differently. Identifying inflation in your organization is a key skill to help you make decisions to guard your margins.

To identify inflation quickly and conclusively within your organization’s product mix, know historical and current revenues, costs, and margins. Track leading indicators to help identify inflationary trends early.

To guard against supply chain disruptions, consider strengthening existing supply chain relationships, developing redundant suppliers, establishing long-term contracts with suppliers, and carrying bigger inventories of key components.

As costs of products and services begin to grow, knowing current spending levels in key categories can aid cost-cutting decisions. Cost-cutting considerations include substituting alternative materials or labor, assessing import versus domestic sourcing, and adjusting delivery time length.

2. Labor

Inflation’s impact on wages and, in turn, on the cost of labor to an organization is usually easy to measure and identify. However, having a pure cost approach to managing labor can have significant negative impacts to your organization’s cohesiveness.

Inflation can quickly impact high-demand and minimum wage positions. Look for ways to reduce your dependence on these classes of labor through scrutiny of the type and method of activities performed, evaluation of products and services offered, and elimination or automation of activities.

3. Pricing

increasing prices of the products or services you offer may be the most obvious decision to make during inflationary periods. The timing of price increases can have significant impacts on profitability. Leaders are frequently too slow to recognize signs of inflation in costs, and then don’t raise prices quickly enough.

Price increases don’t have to be across the board. Increases can focus on your differentiating products, with a marketing focus on distinctiveness and strength of brand, while targeting less price-sensitive customers.

Understanding the elasticity of customer demand for each product is important to implementing a successful price increase. Also consider building variable pricing into contracts with customers.

Stress-test your tolerance

To make informed decisions, run tests to financially quantify the impact of inflation and corresponding decisions. A strong financial modeling tool allows you to see the expected causes and effects of multiple impacts and/or decisions before you make them.

Running various “what-if” scenarios can help you stress-test your organization’s tolerance to inflationary pressures and potential responses. Models don’t have to be elaborate, nor have a long history of use. Use a simple model that mimics true financial behavior, allows you to easily adjust key assumptions, and has buy-in from leadership.

How we can help

CLA links deep industry knowledge and experience with your specific situation. Our team can look at how various factors may influence your future, in order to highlight new opportunities and risks and allow you to react and respond in real time to the opportunities and challenges on the horizon. We can assess your current financial modelling approach, or, offer our CLA Intuition® financial modeling process.

 

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