How Inflationary Forecasting Affects Companies
Much has happened during the last 20 years. The world has lived through everything from an economic crisis to a pandemic. Between these two events, the world economy thrived and was characterised by increased globalisation and low inflation. One effect of this is that many of today's company leaders are too young to have any experience handling today's rising problem – inflation.
In this article I will talk about what impact inflation could have on companies and what this demands of forecasting.
Even though the strong inflation we’ve seen during the last year will likely flatten out, the inflation is predicted to stay at high levels for the upcoming years. It’s also a risk that it will remain until the next recession and lead to so-called stagflation. Even though today’s world leaders have broad experience in handling crises and changed world situations, few have the experience and knowledge to work actively with forecasting and decision-making in times of high inflation. This demands different methods than we are used to, and companies have different possibilities of handling the situation. For some companies, it’s easy to alter their prices at the same pace as inflation while others work with fixed prices and long term deals. Some contacts are index adjusted, while others aren’t and so on. The companies that will have to fight the hardest are probably those with price-sensitive customers and few or no possibilities to lower their cost base.
Which costs can we control?
Today we can observe increased prices everywhere, from fuel to food and electricity. Therefore, companies must master the art of modelling increased costs and expenses at the same pace as inflation. In some cases, the company's expenses will increase without having any chance to impact them. One example of this is, for example, housing costs and transportation costs. Because of this, it will be even more critical for the companies to work actively with the expenses they can affect. For most companies staff costs will be the primary cost item that they can affect, and it will be crucial to keep the increased staff costs under the pace of inflation for the products and services sold.
Tips: Read our article Opportunities (and problems) with rolling Forecast, where we talk about different Forecasting methods.
“What the wise do in the beginning, fools do in the end.”
― Warren Buffett
The increased inflation also makes it even more important for companies to keep an eye on their payment flows and get the payments from the customers quicker. Previously many smaller and mid-size companies have chosen not to work actively with optimising their payment flows. However, in today's situation, with high inflation and increased interest rates, a payment further away in time means that the amount is worth less and that the rates of the capital needed to finance the company whilst waiting for the payment are higher. Ultimately, a company must keep or increase its cash flow to continue to create value for owners and other stakeholders.
Inflation requires new demands on forecasting.
Today’s companies must consider how their businesses will grow in times of inflation. If a company increases their sales by 5% and the cost inflation for its goods is 7%, it will impair its results and hollow out its equity in the long run.
To prepare the business for different scenarios and simultaneously control how the inflation will affect the company, it is vital to separate the inflation effects as specific budget drivers. A modern system with a functionality for a driver-based forecast and automation is recommended not to make the manual forecasting work even more complex. A system like this can also be helpful for companies who’d like to adjust their comparative figures for inflation and be useful support for analysis and follow-up.
Are you interested in learning more about inflationary forecasting? Contact us for a free consultation with me or one of my colleagues.