Demystifying Inflation

Demystifying Inflation

Inflation – it’s a word that’s been on everyone’s lips recently. Rates are on the rise, and our small business community is feeling it the most. Increased supply costs, a lack of workforce, and dwindling profits are among the challenges faced. 

Let’s demystify inflation and delve into its impact on small businesses.

Grasping Inflation

In essence, inflation is the uptick in the cost of goods and services. Whether it’s a can of beans or a property, prices creep up. This fluctuation is driven by numerous factors including supply and demand, production costs, staff shortages, monetary expansion, and wage increases.

While it may seem counterintuitive, a certain degree of inflation is intentional. Economists broadly concur that a 2% annual inflation rate is optimal, striking a balance in the economy while fostering growth. This modest rate enables central banks to decrease interest rates, stimulating the economy without burdening consumers excessively. 

Despite this consensus, the intricate nature of inflation and its implications often spark spirited discussions. Though we can’t control inflation as individuals, understanding its implications for our personal finances is critical.

How does inflation affect small businesses?

Small businesses, with their limited financial buffers, are especially susceptible to inflation. As inflation pushes up the cost of goods and services, small businesses must grapple with these increased expenses with fewer resources at their disposal. Picture this: a small business sells a product for $10. Suddenly, production costs rise to $12 due to inflation. The business is then faced with a tough decision – absorb this extra cost or pass it onto customers, potentially harming sales.

One of the key features of inflation is the erosion of consumers’ buying power. When your savings grow at a slower rate than inflation, you’re effectively losing money. The interest earned on your savings account needs to outpace the inflation rate to preserve its value. With global inflation currently outstripping the average savings account interest rate, you might find your money doesn’t go as far as it once did, even though the dollar amount remains the same.

Navigating with the Rule of 72

To get a rough idea of what this loss of buying power looks like, let’s turn to the Rule of 72. Though it’s a rough estimate and doesn’t account for varying inflation rates over time, it’s a useful tool to envision what might happen to your money if the current rates persist.

To estimate how long it’ll take for your savings to double, divide 72 by your annual interest rate. Let’s say you have $100 in a savings account with a 2.5% interest rate. According to the Rule of 72, it’d take about 28.8 years for your savings to reach $200.

The Rule can also help you gauge how quickly inflation might eat into your savings. Divide 72 by the annual rate of inflation. If the inflation rate is 6.5%, for example, it’d take just a little over 11 years for your $100 to be worth half its value.

This illustrates why an inflation rate exceeding the interest rate earned by your customers can be a challenge. As prices go up, consumers become more hesitant to buy goods and services. If small businesses have to raise prices to cope with inflation, it could further affect consumer purchasing power. Therefore, it’s crucial for small businesses to adjust to inflation to stay afloat.

If you’d like to talk about steps you should take in your business, get in touch with us.

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