(This column originally appeared in the Philadelphia Inquirer)
If you’re running a small business, I advise you to brace yourself: 2023 — at least the first half — is going to be tough. I see it in the data, and I hear it from my clients. We all face at least two big challenges in the year ahead: inflation and higher interest rates. Here’s what you can do to cope.
Higher prices will continue to torment us for the foreseeable future. Right now the Producer Price Index, which measures the cost of making things, is up 7.4% year over year. But that figure is made up of many different parts. When you drill down into the details, you’ll see that the cost of the core materials and labor that most businesses are paying have increased much more.
For example, those in the construction industry are still seeing building material costs up 18%, steel piping up 12% and cement up 15% over the past year. Manufacturers are dealing with 11% higher costs. Agriculture businesses are buying fertilizer and animal feed at 15% and 16% higher prices than a year ago. Retailers ordering products from overseas are paying 33% more for shipping.
As for labor, hourly workers are getting 14% more than they did in 2020. Salaried workers are earning 7.6% more if they stayed on the job, according to payroll company ADP — and 15% more if they switched jobs.
And let’s not forget that, thanks to various stimulus spending bills, more than $6 trillion in circulation since 2020 is chasing too little demand, another significant cause for inflation.
So what can business owners do in these inflationary times? Here are a few things I’ve been recommending to my clients.
- Target price increases. You shouldn’t be doing across-the-board price increases as it could potentially hurt demand. Instead, leverage your accounting data and target your price increases on specific customers and product lines where you need to protect margins.
- Communicate with your customers. Keep them up-to-date on backlog, project status, or future price increases.
- Practice “shrinkflation,” the practice of charging the same for a product or service but providing a little less. Just google shrinkflation, and you’ll see all the big brands that are doing this.
- Stock inventory if you can because prices are continuing to rise. Buy property and equipment, as well, if you’re able because these assets tend to perform better in inflationary times. If you need financing, apply for a Small Business Administration 7(a) or 504 loan where you will have a higher chance of approval.
- Forecast. Project your cash out over at least the next 90 days. This is not as hard as you think. You know your monthly overhead. You know your margins. You’ll need to estimate your sales based on backlog, open orders, pipeline and history. Once you do this and take into account any unusual items in the next three months (estimated taxes, a big supplier payment), you should have a much better idea what your future cash will be. If you have a good idea what’s coming, you’ll be better prepared to deal with those challenges.
The Federal Reserve has dramatically increased interest rates since the beginning of this year, and more rate hikes are planned. It’s a key tool for reducing inflation as it helps to restrain the supply of money in our financial system. Unfortunately, small businesses are already feeling the impact of higher rates. Interest charged for most commercial loans to my smaller clients who have less collateral and are deemed riskier than larger corporations exceeds 10% and is increasing.
This means that small businesses will need to limit borrowing in 2023 (assuming they can even get approval as credit continues to tighten). Working capital and equipment loans are now — and will be — much more expensive, which will cause many of us to reconsider some inventory and capital purchases. It won’t eliminate these purchases, but we will all have to do more to determine whether they’re truly providing a reasonable return on investment. In the days of lower rates, this was easy. Now we have to be much more careful and analytical.
Labor shortages, a slowing economy and national and local regulations will continue to add to our headaches. But inflation and interest will still be the two biggest challenges.
Take heart: It is going to get better. That’s because, even with the risk of recession, the Federal Reserve is taking the necessary steps to restrain inflation by increasing interest rates and allowing its balance sheet of excess cash deplete to more manageable levels. Also, the supply chain issues that have been a big factor are dissipating with most ports reporting negligible container ship backlogs.
But bringing balance back to the economy will take time. So for at least the first half of 2023, consider some of the strategies above. They should help.