How can CFOs prepare for inflation?

In this article, we discuss the impact of the UK’s escalating inflation rates on small businesses.

We also explain how CFOs can prepare as inflation bites, work with their senior leadership teams to view the business through a different lens, and reveal our top survival tips.

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We answer the following questions:

Why is the rate of inflation in the UK so high?
How does the current economic environment affect smaller businesses?
How can CFOs prepare for inflation?
Does inflation affect fundraising?
When will inflation start to fall?

Why is the rate of inflation in the UK so high?

There a several causes driving inflation now:

Higher energy prices are the main driver behind the UK’s current inflation rate. Cost pressures in UK businesses stemming from higher energy prices, increasing interest rates and wage inflation are also feeding through to higher consumer prices. Companies are now charging more for their goods and services because their costs have increased.
It is also now known that there are more job vacancies than people to fill the positions. Fewer people have returned to the workforce in the post-pandemic world, and combined with the residual impacts of Brexit, employers must now offer higher wages to attract and retain talent.
More recently, the record fall in Sterling made imports more expensive for UK businesses but exports more competitive. Alongside the increasing cost of borrowing for the government, businesses and individuals now face higher interest rates.

So far, the Bank of England has attempted to reduce the UK’s current inflation rate to achieve the 2% target by increasing the Bank Rate to 3.5% whilst working closely with the Treasury to cure demand and supply-side issues.

How does the current economic environment affect smaller businesses?

Higher costs

Smaller businesses are beginning to feel the impact of escalating inflation as costs outside their control have increased sharply. This is having a direct impact on cash flow and the bottom line.

Following the dramatic fall in the value of Sterling during the autumn, companies dependent on imports must now charge a higher retail price for their goods and services.

Even though export-led UK businesses are conversely now more competitive in world markets, it is a time of great uncertainty, and the global market is a complex environment to sell into right now.

Business debt

Smaller businesses with loans must understand how this debt affects their current financial position.

For example, businesses with variable interest rates on loans are now exposed to inflation because the usual reaction from the Bank of England is to increase interest rates, which increases the cost of servicing debt.

At its December 2022 meeting, the Monetary Policy Committee voted by a majority of 6-3 to increase the Bank Rate by 0.5 percentage points to 3.5% as the Bank of England vows to tackle soaring prices. Theoretically, this may alleviate some inflationary pressures on the demand side building up. Still, increased interest rates mean small businesses with debt must be vigilant with their finances until rates decrease again.

Increased wages

Periods of inflation are usually accompanied by wage pressures as workers push for higher wages in line with inflation. This has been demonstrated recently as unions and workers campaign for higher pay in various industries. However, smaller businesses may have fewer employees, but they will struggle to offer higher pay, especially when these increased costs cut into their profits.

There are two different channels through which wages are rising:

Firstly, the lack of employees creates a supply issue that subsequently gives employees bargaining power when negotiating salaries.
Secondly, as economic confidence is low, workers will often see headline inflation as a reason to account for this in their salary expectations.

How should CFOs prepare for inflation?

For CFOs, it is possible to guide a company through harsh economic conditions and minimise the impact of inflation. This can be done by:

Reducing costs

Since costs are rising for UK businesses, reducing these overheads is one of the main ways CFOs can prepare for inflation.

CFOs evaluating the business’ expenses to identify where costs can be cut could look to renegotiate contracts with more favourable terms or engage different suppliers.

By evaluating discretionary spending and the costs the business has the power to change, CFOs can gain greater visibility of the pressure points in the business exposed to inflation.

Most importantly, cash flow management is essential in periods of high inflation so CFOs can monitor the business’ outgoing expenses and ensure it matches or is less than income.

Related Article | How to manage cash flow during economic turbulence

When cutting costs, it is prudent to look at the link between costs and revenue. If outgoing funds do not funnel back into the business, consider cutting the cost.

Implementing innovative technology

Automation is a popular cost-saving tool for many smaller businesses. Digital solutions can help unlock employees so they can then deal with more complex issues or engage in revenue-generating activities.

There is a plethora of products that provide these solutions to reduce manual input, and they can be implemented immediately.

If the workload of manual staff is reduced by automation, it is something that can significantly reduce costs.

However, this can be a double-edged sword. Implementing innovative technology is not usually a short-term fix, and often businesses need to borrow to fund the purchase of this equipment.

With interest rates already high and expected to increase further, borrowing is now more expensive, so investing in innovative technology may not be the best route, especially if the business incurs redundancy costs because of automation.

Alternative funding streams

While some costs can be eliminated, and pricing can be adjusted to help increase revenue, it may be that your small business needs a significant cash injection to continue operating.

However, in times of inflation, many traditional finance options are simply too slow to be of any assistance. For example, equity and debt funding from institutional investors, such as banks, venture capital, and private equity investors, requires additional layers of planning to ensure the business can secure investment.

In the current environment, forecasting and cost control are the cornerstones of any business. However, even though some businesses may experience a downward trend in sales, there may be opportunities to grasp government assistance through grants and other industry support mechanisms.

Related Article | How to use EIS to attract an investor

Does inflation affect a CFO’s ability to fundraise?

The short answer is it depends.

The stock market was remarkably buoyant during the pandemic, given the existential threat to businesses. Despite the strength of technology stocks underpinning much of this, those same technology stocks have weakened significantly in recent months, and there has been a counterbalance with more traditional stocks. For CFOs in the technology sector, those reductions in valuations make it harder to float businesses and raise cash.

However, while rising inflation is a barrier for many businesses, there may also be reasons for optimism as businesses make strategic adjustments to better position the business for the next few years.

How may the current inflationary situation progress?

The Bank of England previously said it will not hesitate to raise interest rates “by as much as needed” to return inflation to the 2% target. It also said it was monitoring developments in the market after the pound fell to a record 50-year low against the dollar in October. Since then, it implemented an interest rate hike to 3% in November 2022 to combat the 40-year high cost of living, unwound its quantitative easing position, and issued stark warnings of a “very challenging” two-year recession.

Following these unprecedented changes and its December 2022 meeting, the MPC increased Bank Rate to 3.5% but indicated it was likely to raise interest rates further in 2023.

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