Agricultural Trends

August 19, 2022

How Inflation Gets Businesses in Trouble

By Dr. David M. Kohl

A lender had an interesting comment the other day at one of the lending schools. She indicated that her customers who experienced inflation in the 1970s are much more accepting of fee increases and cost increases in general. This was in contrast to those in the younger demographics who have only experienced inflation greater than 5% one time in the past 30 years. The reality of inflation is starting to settle in, cash savings are dwindling and credit card debt is beginning to soar to cover inflated costs.

If not managed, inflation can get a business or personal household into financial difficulty very quickly. For example, if commodity prices abruptly decline while costs remain elevated, this could create negative or squeezed margins that can quickly add up in an inflationary environment. In this situation, the first signs of distress are higher balances on working capital lines of credit, accounts payable and credit card debt.

High fixed cost structures, such as cash rents, debt service commitments and overall overhead costs, can leave a business less agile and backed into a corner. Now is the time to shed unproductive assets, including both capital and human assets, to increase flexibility. The survivors of the 1970s and 1980s often scaled back operations and focused on efficiency while also being effective.

All businesses and individuals should expect to pay higher taxes, whether it is real estate taxes or other taxes at the local, state and federal levels. The other day, I examined my rental car fee and found that the taxes were nearly as much as the rental car base charge! In other words, an increase in inflation basically increases the total taxes without necessarily increasing the tax rate.

Managing through an inflationary cycle requires more than annual financial statements. Your financials must become a living, breathing document that is projected and compared to actual results so that adjustments can quickly be made in business activities.

Knowing breakeven points and your cost of production can set and reset marketing and risk management strategies in order to gather profits on the upside and downside of pricing.

Inflation can turn into problems if the Federal Reserve raises interest rates too fast and too much. With two quarters of negative Gross Domestic Product already under our belts and with the consumer becoming much more selective with expenditures, a recession is possible. A recession with high rates of inflation is the 1970s all over again and it is called stagflation. Stagflation is an environment that is very troublesome which erodes earnings and wealth at an accelerated rate, making people feel less wealthy.

Dr. Kohl is Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship in the Department of Agricultural and Applied Economics at Virginia Polytechnic Institute and State University. Dr. Kohl has traveled over 10 million miles throughout his professional career and has conducted more than 7,000 workshops and seminars for agricultural groups such as bankers, Farm Credit, FSA and regulators, as well as producer and agribusiness groups. He has published five books and over 2,500 articles on financial and business-related topics in journals, extension and other popular publications.