The Effects of Inflation on Small Businesses

After the Federal Reserve raised the federal funds rate from 0.25% to 0.5% in January 2022, 85% of small business owners confirmed that global economic trends negatively affected their business. According to the U.S. Chamber of Commerce, inflationary pressure is the foremost concern of small businesses. Inflation forced small businesses to modify their inventories due to product shortages and increasing raw materials costs.

Overall, small businesses have reduced purchasing power, forcing them to absorb losses within an already bleak profit margin. Surging inflation encouraged more businesses to raise prices, decrease staff, and take out a loan.

In this article, learn which industries are most affected by inflation and how inflation impacts small businesses.

How does inflation arise?

Inflation is the rate of increase in the value of goods and services. Surging inflation rates mean that the purchasing power of money decreases. According to the Bureau of Labor Statistics, the consumer price index (CPI) rose by an alarming 7.9% from 2020 to 2021. This is the CPI’s fastest annual increase since June 1982.

The current rising inflation since the COVID-19 pandemic includes the following factors:

  • Worker shortages
  • Produce shortages
  • Rising wages
  • Increase in money supply
  • Fossil fuel price surge
  • Supply chain disruptions

Which industries are impacted the most by inflation?

Due to rising inflation, small businesses need to stay vigilant about their expenses in light of increasing prices.

According to FinancialExpress.com, the top industries most affected by inflation amidst the pandemic are:

  • Energy
  • Real estate
  • Health care
  • Utilities
  • Consumer staples

This section will focus on the most affected industries due to the current inflation situation: the perishable goods, energy commodities, and vehicles industries.

Perishable goods (meat, poultry, fish, eggs, and produce)

According to the Bureau of Labor Statistics, the price of grocery items rose 0.5% in December 2021 alone. Food prices increased by 6.3% on a year-over-year basis, the highest annual move since October 2008.

The cost of meat is up 14.8% year-over-year. Meanwhile, the price of eggs increased by 11.1%. This is followed by fats and oils and fish and seafood, with prices rising at 8.8% and 8.4%, respectively.

Surging shipping costs is the primary driver of the increasing prices of perishable goods. Apart from the price pressure on crude oil prices, logistics supply constraints also caused the rising cost of perishable goods.

Energy commodities (crude oil, heating oil, natural gas, and gasoline)

Energy costs were the main instigator of rising inflation in 2021; they accounted for 7.3% of the Consumer price index in December. Fuel costs rose 42%, while gasoline prices rose 50%.

On a month-over-month basis, energy commodities are up 3.5% in February 2022. This accounts for a third of the annual increase. Because of rising fuel costs, small businesses are spending more to fill up their tanks and dispatch vehicles. The price of utilities will also increase due to rising energy costs. Traveling and commutes are also affected, which is why businesses are pushing for remote work opportunities.

Apart from rising gas prices, energy costs, directly and indirectly, affect the price of products, particularly petroleum-based materials.

Supply chain issues caused by the pandemic and the war in Ukraine will also affect small businesses’ capacity to ship products. Freight services and logistics firms will likely increase their shipping costs and surcharges.

New and used vehicles

According to Jared Berstein, a White House economic adviser, the used car industry has a historically high impact on headline inflation. The Labor Department estimates that the used vehicle industry contributed 0.112 percentage points to the overall 0.5% inflation increase.

Aside from shelter and gas, the used vehicle industry is a major driver of inflation. Supply chain constraints caused an inflation increase due to used vehicle prices during the coronavirus pandemic. This resulted in limitations to new vehicle production, increasing the inflation rate from 2021 to 2022 to 37.3%.

How inflation impacts small businesses

The previous section gave you a brief look into how inflation affected various industries across the U.S. Unfortunately, the most vulnerable sectors to inflation are small to medium-sized businesses.

Raising prices for products

According to Business.org, 89% of small businesses have increased prices since the start of the pandemic.

Due to supply chain constraints and labor shortages in the logistics industry, small businesses face the overwhelming price increase of raw materials. Small businesses need to raise the pricing of their products and services to offset rising costs.

Decreased purchasing power

The direct impact of inflation on businesses is decreased purchasing power. To skimp on expenses, many small businesses choose to modify their inventory.

Instead of keeping multiple stocks on hand, a 2021 Business.org survey showed that 46% of small businesses planned to reduce their inventory for 2022. Small businesses will choose to save costs by maintaining a minimum inventory.

Narrow profit margin

While small businesses increase the prices of their products, profit margins continue to narrow as businesses absorb higher costs.

Small businesses need to accurately account for their expenses to reduce the impact of narrower profit margins when determining the proper pricing. Small businesses often fail to consider hidden costs such as employee benefits, taxes, and loan interest payments.

Expensive shipping costs

Undoubtedly, the pandemic worsened supply chain constraints and labor shortages in the logistics and shipping industry. This caused the rate of freight services to increase astronomically, to the dismay of small businesses and consumers.

With increased inflation, shipping costs will continue to rise, especially due to rising energy costs for four-wheel vehicles, air travel, and utilities.

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