The Perils of Inflation
Since our formation in 1996, vcfo has helped our clients through a number of booms and busts (.com, semiconductors, Real Estate, Energy, etc.), total economic melt downs, (2000, 2008), terrorist attacks, pandemics (bird flu, swine flu, coronavirus), natural disasters (fires, earthquakes, hurricanes and floods), and geo-political tensions and disruptions.
Now, our clients are facing a new threat – inflation. Many managers and business owners have not led through inflationary times, so let’s get prepared to fight inflation quickly.
Time tested business plans will simply not work without adjustments as inflation takes hold. Many of the below suggestions are positive ones to undertake in good times or bad alike, but they are must haves in an inflationary environment. It is critical to focus on inflation now and make necessary changes to your operating plan to combat it.
A starter set of recommended action items follow below to get you moving in the right direction:
Know What to Watch for and How to Monitor Inflation
Start the process by educating yourself on the insidious and dangerous impact of inflation. Understand the difference between the CPI (Consumer Price Index) and PPI (Production Price Index) as well as the main drivers of inflation. It is in your best interest to know what is happening on a regular basis which may be daily, weekly, or monthly depending on your circumstances. Some of the basics of inflation are covered here in one of our previous blogs.
But what to do once you know?
Know Your Costs
Make sure you truly know what it costs to produce your product or service in this changing environment and know that it is changing weekly for some companies. If you are a product company, pay close attention to the PPI for advance insight to increasing costs headed your way. Understand your overhead because inflation is hitting there, too. For many companies, salaries are a large component of overhead. Salaries and other labor costs are definitely subject to inflation increases. Do you know your contribution margin by product, by service? You need that level of visibility and analysis. Insight into your business and the drivers is more critical today than ever before to support the best decision making.
Cash Flow Cycles
Know your AR Turnover. In an inflationary environment, if you provide your customers credit terms, intentionally or not, you are making a sale in today’s dollars that will result in you being paid with less valuable dollars at a later date. If you allow your accounts receivable collection cycle to extend too far out, you are essentially losing money on every sale due to timing. As an example, inflation ran at more than 6% by every measure in 2021. Sales made with six month terms for payment (negotiated or allowed through inattention to collection) cost you 3% in profitability on average. Do you have that kind of room in your margin? Whether you do or not, don’t give it up unintentionally. Spend time and energy on collections procedures. Reducing cycle time (or AR turns) takes time – this is a good exercise in any environment and critical now. The opposite is true on your AP cycle; if you can negotiate longer terms you are receiving a time value of money discount.
Understand the Element of Time and Money
Don’t hesitate to make necessary price increases. Every day you delay a necessary increase is a day of margin you cannot recover. You must stay on top of your pricing and be proactive in an inflationary environment.
Diversify Your Ability to Take Payment in Various Ways
Consider whether setting up credit cards and/or the ability to take payment in alternative currencies is advantageous for your business if it accelerates payment.
Fix Your Debt
Do you have variable rate debt? Lock in a fixed rate if you can. Restructuring a company in terms of the debt capital stack, takes time. A discussion about debt restructuring is an excellent lead in conversation item with prospective bankers. If you do not have ample flexibility on your lines of credit (and if they are variable in nature,) ask for solutions to move variable rate debt to fixed rates.
If you have significant debt, you may want to consider other options. There are other solutions, such as “interest rate swaps,” that can mimic changing your variable rate debt to fixed. These solutions also have a cost, but can be advantageous in a moderate to high inflation environment where rates are rising monthly. Keep in mind, swaps are financial contracts that can be broken if necessary.
If you want a lesson in who survives crisis from these types of exercises, look no further than what happened to General Motors in 2010 and how Ford avoided GM’s government takeover experience. Ford shored up all of their debt and lines of credit when the times were good. We often say there is no better time to negotiate debt than when you do not need it.
Now is a good time to explore diversifying your lenders. Prospective lenders will get creative and aggressive if they want some (or all) of your business.
Leverage Your Relationships
It is important to retain your customers and to ensure they do not leave you as prices increase. If you are forced to raise prices you can bet your competition is either doing so as well or will be soon. If they aren’t, they will be negatively impacted very soon. That won’t stop them from pointing your increases out. Price increases can create vulnerability points with clients. You should always stay in close contact with your clients, and even more so during this inflationary period.
Know Your Value Proposition
Be sure you are communicating your value proposition in all that you do. This is particularly important when you are conveying why you need to raise prices and why you are still the partner that delivers what a customer needs.
Engrain Innovation and Lean Mindset Into Your Culture
Continually reinvent your processes, services, and products. Engage your employees to work together to eliminate costs & unnecessary steps, boost productivity, and streamline your supply chain.
Understand Your Supply Chain Risks (and Opportunities)
Understand where you are vulnerable in the process of making your product or service. Tesla managed the supply crunches in the past year relatively well. Now other industries are taking a serious look at Tesla’s model for diminishing supply chain risks. A vital component of their process is to keep design components in-house while owning critical parts of their supply chain from the source. Tesla’s success during the supply chain crisis made companies relook at their critical vulnerabilities and dependencies.
It is not just auto manufacturers that are now looking at reviving old domestic factories and acquiring critical organizations and assets down their supply chains toward the source to mitigate dependencies. Eliminating the middleman and not outsourcing as much of the process allows for faster supply acquisition and effective buffer stock management. Hardware design and software development were two aspects integral to Tesla that other industries are now looking at imitating to increase pliability in the face of supply chain disruptions. In an inflationary period, this strategy also provides more cost control opportunities.
We run an EOS organization and many of our clients do as well. In summary, EOS, the Entrepreneurial Operating System®, is a complete set of simple concepts and practical tools that has helped thousands of entrepreneurs around the world get what they want from their businesses. Not only does the EOS process keep our team focused, but we also creatively discuss problems/actions/solutions…like how to fight inflation. This methodology keeps us aligned, it keeps us accountable, and we plan for the future on a routine basis. It can be integrated with lean six sigma as well. Implementing EOS, or a similar system, will help you and your leadership team get better at three important things:
- Vision – Get everyone in your organization 100% on the same page with where you’re going and how you plan to get there.
- Traction – Instill focus, discipline, and accountability throughout the company so that everyone executes on that vision – every day.
- Healthy – Help your leaders become a more cohesive, functional, healthy leadership team. Tie accountability to your performance incentive plan or long-term incentives that are included in employee compensation.
Retain Your Team
Retaining customers is a close second to retaining your most important asset – your employees. Be proactive about compensation trends in an inflationary environment. Losing a key employee can take months to replace and that one employee can take months to get up to full speed. If you replace that employee, you are going to pay full price and then some. When making decisions in this area, think in terms of time and money invested in your workforce. Consider what they bring to the table, but also, what will be lost in terms of time and resources if they leave. Long term incentive planning, such as stock option plans or stock appreciation rights (SARs) are good ideas to help incent your top talent to stay with you through thick and thin. Another option might be retention bonuses. It is imperative to incorporate periodic (and for key employees, frequent) updates to salary benchmarking studies and hourly pay benchmarking. Benchmark employee compensation to competitors and across industries. With shortages in the labor market, and an ever-increasing virtual marketplace for talent, it is not only your competitors and your own geography that are you are competing with for talent!
Assess Holes in Your Expertise
If you read the above items and thought to yourself, “I really need to start working on that,” don’t wait. Inflation is here now. Once it really starts moving, the skills and talent to address it will be in high demand. Opportunities you could have taken earlier will have closed. If you need some help figuring this out, ask now. Make the changes you need to put yourself ahead of the curve.
If you need help assessing your situation and making the necessary changes to survive and even thrive in an inflationary period, call vcfo. Our team of seasoned experienced CFO and HR professionals can guide you to a successful outcome.
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