As we enter a period of recession and higher-than-normal inflation, everyone is scrambling to identify how it might affect their businesses and what they can do the manage the impact. This is a challenging exercise because we don’t really know how persistent this inflation will be and what ancillary effects might come as part and parcel of the macroeconomic shock. As such, companies should be preparing for all scenarios and that’s where a sophisticated FP&A tool like Apliqo FPM can be so useful.
To give you a sense of how this looks practically, let’s examine some potential inflation scenarios that you might be thinking about as a company.
Increasing cost of capital
As inflationary pressures increase, most governments will seek to increase interest rates to try and stabilize the economy. This monetary policy can have drastic impacts on borrowing and investing practices – which increases the cost of capital across the board. Therefore, if your company is in the process of launching a new product, rolling out new branches, expanding internationally, or recapitalizing your balance sheet – this is going to be a hit to your calculated ROI.
If you’re in this position, it’s worth relooking at your current plans and identifying whether you can slow down these efforts or postpone them, or perhaps find alternative sources of funding that can mitigate against these rising costs. What makes this problem so insidious is that the leverage that is locked in at these moments has significant compound effects on the success of any new projects. So if you do believe that this inflationary spike is going to be temporary (as many economists do) then it’s worth utilizing a flexible rate rather than a fixed one – so that you can benefit from future relief.
Decreasing consumer purchasing power
As the impacts of inflation hit consumers, it’s natural to see a decrease in demand across a wide variety of product verticals. Households whose purchasing power has diminished cut down on spending to try and maintain equilibrium – especially because wage increases can lag quite significantly behind cost of goods increases. As such, you need to be aware of what this will do for the demand for your specific products.
Good practice is to do an analysis of the price elasticity for each product line and assess how much of the inflation you can pass on to customers before it starts eroding your profitability. You might rely on past data for this if you have been tracking the impact of pricing on demand – but you can also run small experiments by testing different pricing methodologies and seeing how they affect sales.
This is as much a science as it is an art, but it’s the sort of exercise that can be invaluable when trying to figure out how much of the inflation you can pass on, and how much you’ll have to stomach yourself.
Increasing costs of raw materials
Another potential impact is that the costs of production can go up significantly as raw material prices are the most vulnerable part of the value chain when it comes to inflation. If you operate with raw materials then you’re likely already in difficult conversations with suppliers as everyone tries to adjust to the current state of affairs.
When you’re in this situation, it’s all about understanding the bargaining power that you have in these negotiations, and being very precise about what you’re trying to achieve. If you have a high concentration risk on one particular supplier then you probably don’t have much room to wiggle, but if you have different options available to you – you can then seek a mix of supplies that best suits you and your needs. Inflation will affect different suppliers differently, so work to understand their unique situation so that you can make an informed and holistic decision.
It’s also worth noting that while price is obviously most important, you also want to consider sustainability and reliability here. These inflationary effects might take months (or years) to work their way through the system and so it might be prudent to weigh up whether fleecing a supplier for as much as you can is a smart long-term strategy. In many cases, it’s better to take a slightly higher price if it means that you can guarantee sustainable supply without any hiccups.
Those are just three potential scenarios that you might be dealing with as inflation rears its ugly head. As a company, preparing for these is all about working with the data that you have and running various tests to assess where you are most at risk.
We’ve seen the clients that this sort of planning are more than prepared for the impending inflation that is working its way through the economy. By utilizing Apliqo FPM, you can get a grasp on what could be coming down the pipeline and you can put yourself in the best possible position to navigate the inevitable economic cycles that are just around the corner.
If you’d like to explore what such an FP&A tool can do for your organization as you prepare for an uncertain future – get in touch today.
