How To Forecast & Prepare For Inflation

How To Forecast & Prepare For Inflation

How to Prepare Your Business for Inflation

No matter how you slice it, inflation is here. Growing freight prices, rising raw material costs, labor shortages, increasing wages are all strong indicators that inflation isn’t receding anytime soon.

So what’s a business owner to do?

Two things you can do as a business owner to prepare for inflation are: 1) monitor costs and secure pricing from suppliers (either over the short-term or the long-term) and; 2) raise your prices. Monitoring costs becomes easier to do when you’re properly tracking your supply chain KPIs. The second thing is to raise your prices.

In this article we review: how to forecast and prepare for inflation, accounting for inflation and how to raise your prices for inflation.

How to prepare for inflation

US inflation soared to a staggering 8.6% in May 2022, the highest upswing in 40 years – and isn’t looking to recede anytime soon. Every business owner, no matter the industry, should be asking how to prepare for inflation. 5 strategies to prepare your business for inflation:

  1. Update forecasts with assumed higher costs 
    1. Examine your supply chain vulnerabilities. For example, increase in shipping freights, raw material costs etc.
    2. How are the prices of your cost of goods sold impacted? 
    3. How is the cost of your labor impacted? 
    4. How are your logistics impacted? 
  2. Calculate any change in margins using the basket approach   
    1. Compare the budget of last year to the current year for an inflation rate specific to your business. Factor in any of the above changes in margins
  3. Aim to have a consistent gross profit margin 
    1. You ideally want to maintain a consistent gross profit margin. While costs of raw materials or products are always a big concern, you must also consider things like salary raises especially given current labor shortages.
    2. Focus on flexing up your high-margin, high-demand products or services
    3. Hit pause on slower-moving inventory or frequent stockout products.
  4. Increase prices 
    1. To prepare business for inflation, take the specific rate of inflation for your business and increase your prices accordingly. (More on this below).

Worried about customers reactions to increased prices? Take a quick look at our guide on how to write a price increase letter for help.

Infograph explaining how you prepare for inflation

How to forecast for inflation

With all the talk of inflation, stagflation and recession, now is the time to introduce rolling forecasts if you haven’t already. So when June 2022 ends, June 2023 is added on. Common forecasting periods are for 12, 18 and 24-months, but shorter is better. Ideally you want accurate cash flow forecasts for the next two quarters. Accounting for inflation requires an examination of all drivers impacted by these rising costs. For example:

Track gross and net profit margin by service or product line to monitor optimal performance.

To estimate the increased supplier prices look at historical gross and net profit margins using the basket approach:

Accounting for inflation with the basket approach
  1. First, compare your profit margins from last year to this year. Note the percentage change for year-to-date (YTD).
  2. Next, look at your original budget for the year. Take your product cost and increase it by the percentage increase you found from last year to this year. That will give you an updated projection for profits for the year, assuming you don’t make any changes to your pricing.
  3. Increasing product costs are the primary concern; but you must also consider potential salary raises. These also impact your bottom line.
  4. Finally, calculate how much you wish to raise your revenue to get an acceptable net profit margin for the remainder of the year. This will show you how much you need to increase prices.

Related Read: 7 Tips to Build a Better Inventory Forecast

Once you are correctly tracking and forecasting the drivers affected by inflation, you can build in those cost increases in your pricing.

Raising your prices for inflation

Go ahead and raise your prices (because everyone else has)

Should you raise your prices? The easy answer is yes. Not only have your costs likely been affected by inflation, but your consumers and clients won’t be surprised.

Thankfully, because so many business owners are in the same boat, there will likely be less backlash from your customers because most people know it is warranted. Even expected.

Related Read: How to write a price increase letter due to pandemic

How to raise your prices for inflation

A simple way to offset pricing for inflation is to take the consumer price index (CPI) rate increase and raise your prices by the same percentage increase. Without doing any further analysis, you could justify raising your prices for inflation by that amount. So, for example, if CPI is up by 7.9% from February 2021 to February 2022, and you haven’t raised your prices in the last 12 months, you might simply raise them by 7.9%.

Accounting for Inflation

That said, while the CPI is great for rough estimations, inflation can vary wildly from industry to industry or even product to product. For example, gas and fuel have increased by 40% or more, which in turn drives up the cost of freight.

So any business that relies on overseas suppliers, costs have significantly increased far above the 7.5% CPI. This has caused many companies to face a two-pronged effect of inflation:

  • It is now taking longer than before to ship via marine transport, which is affecting fulfillment and inventory turnover; and
  • Many have had to resort to shipping by air – increasing expenses further – in order to speed up their orders.

Related Read: 3 Supply Chain FAQs Answered: The Supply Chain KPIs You Need To Know

A business experiencing the above cost increases would need a more granular method of accounting for inflation. The basket approach would provide them a solid strategy to calculate how inflation is affecting their profit margins.

Example: Take a few bills from suppliers from a year ago and look at the freight costs, compare it to your current bills and use the percentage change to determine a price increase that is more specific to your business than the general CPI.

To seize this opportunity to raise your prices don’t overlook the importance of forecasting for inflation. Still not sure exactly how to prepare for inflation? Our ecommerce accounting services provides regular reporting if you opt into our core pricing package.

While the Federal Reserve Bank suggests that this period of inflation is transitional, mid-size companies are no doubt feeling especially pinched. With supply chain rates increasing, but having little experience in how to adjust their pricing without losing customers, it’s no wonder business owners are feeling panicked by inflation. If this sounds familiar, we are here to help. Get in touch to learn more about how business owners can prepare for inflation using our outsourced controller services.

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