Financial Management Tips for Guiding Your Company During Inflation
During inflation, many aspects of financial management must be done more frequently. Costs, prices, and competitor prices all change much more often. Financial leaders help this increased company cadence.
Inflation-Focused Meetings
One process for managing inflation is to hold meetings focused on inflation. A company will only invest this amount of top management’s time if it considers inflation a strategic threat.
Meetings focused on the potential impacts of inflation may initially be held only by financial planning and analysis (FP&A) staff in a company. The goals of these meetings are to run scenarios to model inflation’s impact on the company. If the scenario implications are significant to company strategy, then those scenarios and inflation mitigation would be elevated to higher levels of management.
If inflation is distant at this point, the company only needs to monitor a couple of key indicators of inflationary pressure before enacting mitigation measures.
Companies that don’t recognize inflation until their margins are tightly squeezed will hold these meetings to triage the situation. They have lots of planning work that needs to be quickly done to catch up.
The purpose of these meetings is to assess the current impacts of inflation and develop mitigation strategies. Having people representing multiple functions of a company in the meeting allows quick data assessment, easier coordination of an integrated strategy, and clearer communication.
Financial Management Changes
Meetings focused solely on inflation are likely only needed in the early stages of a company’s response to inflation. After that, it’s better for inflation mitigation to be embedded in current management processes. Here are some examples of how that might occur.
Pricing Management
Companies may need to increase the frequency at which they receive market pricing reports. These reports summarize the prices and tactics of competitors. Since prices are changing more rapidly, market pricing reports become quickly outdated. It also allows faster feedback on competitor reactions to the company’s price changes.
Pricing committee meetings may need to be held more frequently. This allows faster responses to a quickly changing market. It also allows the frequent, smaller price changes.
Inflation and related price changes create anxiety for many. Some managers will try to calm their anxieties via lots of analysis, leading to analysis paralysis. Frequent meetings can hopefully cycle these managers to a decision more quickly. Multiple exposures to reports showing the need for action will create more pressure for a decision.
Key Performance Metric (KPI) Dashboard
The importance of inflation mitigation to company strategy is likely so high that inflation metrics should be added to company KPI dashboards. Example metrics to consider monitoring are:
- Amount of receivables 30+ days past due
- Days Sales Outstanding (DSO)
- Days Inventory Outstanding (DIO)
- Average price per unit
- Cash and liquidity metrics
- Costs of key materials or inventory items
- Inflation rates (e.g., the CPI-U or a relevant PPI)
The concept of a “balanced” scorecard becomes more important during inflation. Revenue targets may be easy to hit. Profit targets may also be easier to hit in the short term if current price increases are paired with old inventory at pre-inflation prices. Other metrics must capture the current or future impacts of inflation.
Budgeting and Forecasting
Annual budgets are quickly outdated when prices and costs are dynamic. A company may need to re-budget during the year. A better option is to switch to rolling forecasts, either in addition to a budget or in place of traditional budgeting. Check out my budgeting course or rolling forecasts course for more information on this.
The cost volatility from inflation is a great way to shock companies out of budgeting inertia. In periods of low inflation, it’s easy to take last year’s costs and add 3% for next year’s budget. During high inflation, costs are increasing at varying amounts. This requires more analysis to determine potential price increases and resulting product margins. That analysis is the opportunity to challenge costs and redeploy resources.
Base case scenarios need to be supplemented with more sensitivity analysis, stress testing, and scenario analysis. The range of potential future costs and prices widens during changes in the rate of inflation. Modeling must capture the breadth of these possibilities. Mitigation strategies need to be developed for likely scenarios or possible scenarios that have severely detrimental outcomes. Scenarios may also provide insights into opportunities.
Historical cost data is much less relevant for analysis during inflation. Using forward-looking costs becomes more important. More components of a product’s cost may need to be broken out because the price increases of each component may be very different. For example, materials costs and labor costs likely have very different patterns of cost changes.
Sales
Sales staff management becomes more important when pricing is the primary mitigation for inflationary pressures.
The sales team may need additional training to prepare them for selling repeated price increases. Finance staff can provide cost data that helps sales staff justify price increases to customers.
A CEO may take a more active role in monitoring sales. Sales managers may set tighter limits on discounts as one way to improve the price per unit.
Incentive compensation structures may need to change. Many compensation programs are based on revenue. Sales staff can get bonuses on rising nominal sales amounts while real (i.e., inflation-adjusted) sales are falling. Companies may consider switching to:
- Profit-sharing: Sales staff receive a percentage of profits or increases in profits
- Profitability hurdle rates: Compensation is only received for sales that exceed a minimum level of profitability
- Performance compared to peers: Incentives are based on increases in market share or sales performance compared to competitor companies.
- Inflation-adjusted goals: Incentives are paid when sales increase over past periods after adjusting for inflation. However, picking an index that reflects the inflationary pressures of a particular company may get tricky.
Purchasing and Products
I’ve said that pricing is the best solution for margin compression, but the purchasing or procurement department can still play a role. They should do their best to reduce cost increases. They are fighting against the tide, but it’s worth the effort.
Inflation is often driven by supply shortages. This can impact a company’s ability to get inventory at any price. The main goal of a purchasing group in this scenario is to secure inventory to maintain production and sales.
Inflation may also put more pressure on reducing the number of products a company sells. Some products consume lots of cash as inventory with poor prospects for future price increases. A purchasing or product group can identify these products and develop plans to phase those products out.
Finance, sales, product, and purchasing staff can all work together to determine optimal inventory levels. Often, this means finding ways to reduce inventory levels. Those levels may be lower than during periods of low inflation.
Communication with Funders
Owners, investors, and creditors are key partners that will want to know a company’s plan for navigating inflation.
Lenders place great emphasis on a company’s ability to produce cash flow. Loans are repaid with cash, not profits. They know how inflation is constraining other borrowers and may have questions for you. This is where the cash projections can be presented to lenders to show the company’s continued ability to produce cash. Lenders know that your borrowing costs with them will be increasing. Lenders will make sure your projections show your ability to withstand those borrowing cost increases. Lenders are also a great source of information on how inflation is impacting other companies and what they are doing to mitigate those impacts. Bankers are also experts on market interest rates.
Owners and investors look both at the company’s short-term prospects for positive cash flow and long-term profit potential. Investors often use dividends to fund living expenses. As their costs rise, they may put pressure on a company to increase dividends. At the same time, inflation is putting pressure on the company’s cash. The CFO will need to set dividend expectations.
Investors will also expect increased returns as rates rise. The CFO will once again have to show how the company will maintain long-term profitability despite inflation pressures.
Communicating with Employees
Inflation creates anxiety. Employees are struggling with living cost increases. I’ve mentioned many changes to company strategy and operations. Change is hard and creates anxiety. A company may be squeezed by inflation, but rumors amongst employees can lead to inaccurate stories of dire circumstances.
The CEO and CFO can both provide factual information to all employees about the company’s current situation and future plans. This will likely squash worst-case rumors. It also puts current company actions into the larger context of company strategy. Leaders should acknowledge the living cost pressures that employees are experiencing and the company’s plans for wages and benefits. Most importantly, company leaders must show their commitment to being fair to their employees.
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