When the numbers come out this Friday, inflation in the United States could climb to 6.8%, a 40-year high.
It would be the highest rate since Ronald Reagan was president in the early 1980s.
And according to many experts – it’s not going down anytime soon.
Seeing as we’ll be living with high inflation rates for the next few years, it’s important to understand how inflation impacts purchasing power, and what it means for borrowing, investing, and spending in the near future.
In this blog, we’re going to tackle purchasing power, inflation, and how they’re intrinsically linked.
Let’s dive in.
What is Purchasing Power?
First things first, it’s important to understand what purchasing power is.
According to Investopedia, purchasing power is the value of a currency expressed in terms of the number of goods or services that one unit of money can buy.
In simple terms, it’s a currency’s buying power. It’s how much you can buy with one unit of currency, i.e. one dollar.
A great way to think about purchasing power is to imagine burying $100 in your backyard this afternoon.
20 years from now, that $100 won’t buy as many goods and services as it will now.
The purchasing power will decrease.
How Does Inflation Impact Purchasing Power?
We can’t talk about purchasing power without bringing up inflation.
Essentially, they are two sides of the same coin.
One measures what a unit of currency can buy, while the other measures rising prices.
Inflation is the increase in the prices of goods and services over time. The Consumer Price Index (CPI) is a commonly used tracker of inflation.
In short, when inflation rises, purchasing power decreases.
How Does a Decline in Purchasing Power Affect Consumers & Businesses?
The natural, short-term reaction to a decline in purchasing power is to spend more.
The ole “if cash will be worth less tomorrow, I might as well use it now” mentality.
In consumers, this can look like stockpiling goods, buying children’s sizes in advance, hoarding gas, and so on.
In business, owners may opt to purchase large expenditures that they would not otherwise buy.
However, rising prices and declining purchasing power can affect businesses mid-to-long term in different ways.
In an industry like retail, reduced purchasing power means that businesses may sell less and potentially lower profits, as every day Americans will not be able to afford what they once could.
In the manufacturing industry, the ability to source raw materials will diminish due to an inevitable shortage in supplies. Many entrepreneur’s funds can become tied up in in-process inventory, wreaking havoc on the entire supply chain.
For businesses across every industry, the cost of borrowing will likely go up as the federal government seeks to slow spending. For financially-strapped businesses, the cost and availability of loans during inflation can cause major concern down the road.
What You Can Do Now To Combat The Effects of Inflation
There are various things you can do now as a business owner to prepare your business for the effects of inflation.
To start, it’s important to be proactive.
Sit down with your accountant to forecast the potential scenarios of inflation. Anticipate wage increases, higher material prices, and disruptions in the supply chain. What will they mean for your business?
An accountant can help you forecast each scenario, and calculate how much your business will need to make it through each situation.
Additionally, it’s a good time to review your pricing. As prices rise across industries, it’s likely that your business, too, will need to raise prices in order to remain profitable.
This isn’t always an easy task, but one that an experienced advisor will be able to help with.
Finally, cash flow monitoring will be crucial during an inflationary period. With the cost of goods and services so up in the air, it’s important to preserve spending where you can.
Finding an experienced accountant, well-versed in cash flow monitoring, is a great way to stay one step ahead of the competition.
If you do not currently have an experienced accountant on call, feel free to book a 15-minute call with one of our accountants anytime.
We’re here to help with any questions you might have.
Until next time.