Inflation - what is it and how it impacts you?

You will often hear about the rate of inflation when listening to the news but what actually is in inflation and more importantly what does it mean for your business?

What is Inflation?

Inflation is the rise in the average price of goods and services in a country. The Consumer Price Index is the measure of inflation you will usually hear about. It is calculated on a ‘basket of goods’, this virtual basket of goods is made up of around 700 items that a typical household buys regularly. The list of what is included in the calculation is reviewed periodically, for example in 2017 gin and non-dairy milks made it in to the basket but basic mobile phones and menthol cigarettes were taken out of the calculation. As a basket of goods is used it is possible that some prices will have fallen but the overall price of the basket will have increased. How much the rate of inflation in the country affects you depends on how much your spending mirrors the basket of goods used.

If the average price of goods and services in the basket has increased then inflation has occurred. Inflation is measured as an annual percentage change. As inflation rises the value of every pound you own decreases, meaning it can buy a smaller amount of a good or service with the same money than previously.

 

What causes inflation?

There are a number of theories about what causes inflation.

One theory is that an increase in demand for goods and services will push prices up. This happens as more and more people want to buy something without an increase in the amount of it available. This is often seen as the cause of house price inflation as the supply is not increasing while demand, particularly around big cities, is increasing.

Another possible cause is costs increasing causing suppliers to increase their prices. This can be caused by a number of things, for example bad weather impacting the supply of crops, or problems with oil supply increasing transportation costs.

Finally, if there is too much money in the economy, the value of each pound will decrease and therefore the price of things in pounds will increase.

 

How inflation impacts you?

Since inflation means an increase in prices, this means your costs of running a business will increase. It may be employees asking for more money to work for you, or the price of your stock rising, but all these items can add up and have a negative impact on the business profits.

You may benefit from inflation if you owe money on a loan or mortgage. Since the loan will be for a fixed amount of money, as the value of money decreases it may become easier to pay off the loan. A £1,000 payment now will be ‘worth’ more now than it will in 10 years time if inflation rises, as that amount of money can buy less.

If you are lucky you may be able to increase your prices to pass on the cost of inflation to your customers and your profits would not be impacted. However, often business owners have to absorb these costs and suffer less profit and have less available to invest for growth. Inflation also often results in uncertainty leading to less investment by businesses and consumers.

If you are concerned about rising prices and would like advice on budgeting or cost cutting please get in touch with us at 2 Sisters Accounting.