They say the only things you can depend on in life are death and taxes. But there’s something else we can always count on to rear its head as well: inflation.
Since World War II, inflation—measured by the Consumer Price Index (CPI)—has reached 5% or higher a total of six times. Now we’re into a seventh, as inflation hit its biggest 12-month increase since 1982, rising to 7.5% in January 2022. And with increased inflation, rising interest rates are sure to follow.
A product of supply chain issues, labor shortfalls and material shortages—combined with increased consumer demands as people try to return to normal as pandemic restrictions lift—this inflationary period brings new misgivings with it. And finance teams—still recovering from a pandemic—are back to wondering what they’ll need to do to lead their businesses through more uncertainty ahead.
To discuss exactly that, Vena’s CFO Darrell Cox and Vice President of FP&A Tom Seegmiller met with Paul Gill, Partner of Valuations and Modeling, Financial Advisory Services at BDO, to chat about inflation and what it will mean for finance teams and their business bottom line. You can listen to their entire discussion in our recent CFO Confidential: Unpacking Inflation livestream—now available on demand to members of Vena’s Plan to Grow platform.
Here’s some of the advice the panel offered finance teams:
1. Watch the Markets Closely
To understand how to react, you need the best and most current data to act on—which means keeping an eye on the markets in real time. Because while understanding past inflationary periods certainly doesn’t hurt, using them as a predictor of what’s going to happen now isn’t always effective. The current supply chain issues, for instance, are more in line with post-World War II inflation than that of the 1970s. But retiring baby boomers are adding to the shortage of workers and the war in Ukraine is affecting the price of gas and other goods. Immigration, meanwhile, offers the possibility of new demand and an increased workforce. All of which factor into the effects inflation can have, Paul Gill said in our CFO Confidential panel.
“If we look to the ’70s and the ’80s, when there was a lot of inflation, it really negatively impacted corporate earnings. Earnings went down and demand got destroyed. Stock prices also went down,” Paul said. “As long as corporate earnings keep outpacing inflation, or even staying on track with it, it's a different situation than we had in the ’70s and ’80s.”
Of course, conditions can change at any time—which is why it’s critical to keep a close eye out. “The biggest risk is if inflation goes out of control—if it goes out of control [and] destroys demand, corporate earnings come down,” Paul added.
2. Re-Evaluate Your Prices
Watching only gets you so far, though—sometimes you need to take action. And while some businesses may be able to absorb any changes caused by inflation, for many businesses—especially those with low margins—there will be no choice but to raise prices. “You can actually go bankrupt pretty quickly if you don't increase prices,” Paul said during the CFO Confidential panel.
That doesn’t necessarily mean raising prices across the board, though. Instead, he suggests a more focused approach that involves finding the best places to increase prices where it will have the least impact on demand.
“You have to understand the price elasticity of all of the different customers that you have. Just break it down,” he said. “Look at it and say, ‘Okay, if I increase prices by 20 to 30% here, will it really impact the demand?’”
3. Don’t Forget To Cut Costs Too
Raising prices isn’t the only way to combat inflation and rising interest rates. Cost reductions can help as well. In fact, it’s something finance professionals should be considering all of the time anyway, Paul said—but especially with supply chain issues affecting the price of goods.
“Because there are so many supply chain issues across the board, almost in every business, I think now is a good time to really revisit what [costs] looks like and look for alternatives,” he said. “That could make a big difference right now just because of the delta between alternatives. There are certain alternatives that are three or four times more expensive while others might be only 10% more expensive. So now's a good time to really revisit the supply chain as well.”
4. Constantly Be Ready To Adapt
With all of the uncertainty at play in the market right now, agility is key. And thanks to the pandemic, financial teams have learned to be more agile than ever, Vena Vice President of FP&A Tom Seegmiller pointed out. Many of the lessons learned over the past two years can be applied to current market conditions too.
“It’s not so different from the early days of COVID,” he said. “Don’t get too anchored in. Be ready for anything. Current data can be so useless at any point in time. Look at micro- and macro-economic inputs and be ready to adapt and reforecast at any time, to avoid and mitigate risks and capitalize on opportunities.”
5. Always Focus on Your Customer
Finally, but most critically, don’t lose sight of your customers or the competitive advantage that you offer them. While price increases may be necessary to stay ahead of inflation, for example, you should always keep in mind your customers’ needs when you’re making them.
In fact, this may be an opportunity to open up a dialogue with your end customer to understand their issues and sensitivity to inflation and price increases themselves, Paul suggested.
Whatever’s happening, he told the CFO Confidential audience, you want to ask “Well, how could this potentially impact my customer? How could this impact the person on the other end, who's driving my business,” he said. “And then just go sit down with them and talk to them.
There’s little financial professionals can do to affect inflation and interest rates in the short, medium or long term. But there are actions you can take to insulate your business from the effects bigger market changes might have and to continue growing despite uncertain market conditions. Which brings us to our last piece of advice.
“Focus on those things within your control,” Tom told the audience of the CFO Confidential panel. After all, that’s all you really can do.
Eventually, like those before it have, this inflationary period will end. You just want to be sure you’re making the best decisions for your business until it does.
To watch the full episode of CFO Confidential: Unpacking Inflation, become a Plan To Grow member and join the community.