Jamie Trull, CEO of Balance CFO LLC, helps business owners make & keep more money through her financial fitness programs.
In 2021 annualized inflation in the U.S. nearly reached 5%, a figure last seen over 30 years ago. Most small business owners have never had to contend with such a significant change in the cost of goods and labor necessary to sustain their businesses.
As a result, small business owners are grappling with rapidly rising costs and falling profit margins, in some cases threatening the long-term sustainability of their businesses.
What does this mean for business owners? How should they move forward in the face of a rapidly changing cost landscape? While knee-jerk reactions are rarely helpful, paying attention to trends and making proactive adjustments when market conditions change is critical to the overall health and longevity of a small business. In order to keep your small business afloat, follow these five tips.
Resist the urge to wait it out.
Many business owners hold out hope for things to get “back to normal” and therefore have resisted making large-scale financial adjustments within their businesses as they wait for stabilization. However, history tells us that periods of higher inflation are rarely followed by deflation to previous prices. In fact, since the 1940s, there have only been three years in which there was annualized deflation (and in each of those years, deflation averaged less than -1.0%).
Review your gross profit margins on a product or service basis.
Many business owners review profit margins when originally setting the prices on their products or services, but don’t have a process for regularly reviewing them to ensure continued adequacy amidst changing market conditions.
As prices for materials and labor increase, it is important to regularly review the impact of those changes on the profit margins of each of the products or services you sell. In a period of higher inflation, reviewing margins at least quarterly is a best practice. Early awareness when your margins are contracting will give you time to review and implement potential adjustments before you run into significant cash flow issues.
Look for opportunities to save.
If a key supplier or ingredient has increased substantially in price, it may signal that it is time to review options and identify possible areas for savings. You may consider switching suppliers, using different materials or buying in bulk (if your cash flow allows for it) to save money.
As prices on more indirect costs—like overhead—increase, this could be a time to review what is really providing a return on investment in your business. Reviewing software subscriptions and levels, bidding out insurance rates and cutting unnecessary expenses and inefficiencies can all assist in maintaining your bottom line.
Have a process to increase prices as needed to maintain adequate profit margins.
To the extent that margins are still declining despite greater cost control, increasing prices is the next logical step.
Too often, business owners view pricing as an emotional decision; however, in reality, it is primarily a formulaic decision based on target profit margins that are sustainable and allow the company to continue to grow and scale.
In most businesses, it isn’t feasible or advisable to be changing prices frequently. This is both inefficient and can cause frustration with your buyers. Instead, in a period of inflation, it is useful to build in some additional “wiggle room” when you do make a price increase so that you have some additional margin built in if costs continue to rise.
Resist the urge to be a martyr.
Oftentimes, small business owners resist passing increased costs onto their customers in a misplaced effort to “help” others. While there may be times it is appropriate to accept smaller margins to assist our customers through difficult times, consistently underpricing is not a viable long-term strategy. Without adequate profit margins, the business will not be able to sustain the resources it needs to serve.
Businesses without sufficient margins and cash flow are much more likely to fail, which is hurtful to both the business owner and the customers they serve. It is the responsibility of a business owner to run a financially viable business for the sake of themselves, their families, their employees, their communities and their clients. Price increases are often insignificant overall to individual customers, but are quite impactful to the overall health of the business itself.
Business ownership is challenging even in stable times. Having a sound financial strategy is critical to weathering any storm, including periods of high inflation. The health and sustainability of small businesses are paramount to the health of the economy overall. If small business owners want to continue to serve their customers and communities in a meaningful way, they must be able to adapt to changing market conditions quickly.