How businesses can mitigate inflation risks

June 1, 2022 BDO CANADA

Inflation is on the rise. The consumer price index (CPI) increased 5.1% on a year-over-year basis in January 2022, according to Statistics Canada. But it shouldn't be a surprise that many businesses are experiencing much larger cost increases.

There are many reasons why inflation is soaring: record low interest rates, unprecedented levels of government stimulus spending, grants and incentives by governments around the world, global supply chain disruptions, a rebound in consumer demand, a hot real estate market, and critical component shortages (such as semiconductor chips), among several other factors. Input costs are rising across the board for consumers, business, and government (e.g., higher energy and labour costs). For businesses in sectors where revenue hasn't yet recovered to pre-pandemic levels, profitability pressures are exacerbated.

With the Bank of Canada set to raise interest rates this year to help tame rising inflation, the stage is set for business debt servicing costs to increase—putting a further strain on cash flows. Rising rates will make operating your business and borrowing to invest in growth more costly, impacting expansion and M&A activities. Increasing rates may impact foreign exchange, making the Canadian dollar stronger and potentially hampering foreign demand for Canadian exports.

Your business has many options available to deal with rising inflation, but there is no easy answer:

  • Raise prices—This is often easier said than done. Getting customers to accept a price increase without impacting demand is a challenging proposition in any market context.
  • Alter/re-engineer your offerings and value proposition—Other options could include reducing the size or volume of a product, changing the design or formulation of your product using less expensive components, or streamlining the service you are offering, but keeping the price the same. This is sometimes known as shrinkflation. At what point will your customers perceive an erosion of value that will impact your sales?
  • Absorb costs—How much is too much? In sectors and businesses with more generous margins, there may be a way to absorb some of the cost increases in the short term. But this is not a viable long-term strategy for financial success, and given the level of inflation being seen, it may not even be a realistic option. It will be bad for the bottom line and could result in financial trouble over the long term.

There are other strategic initiatives your business can take as well, such as:

  • Conduct a business assessment—Analyze overall business performance and cash flows to look for areas where there's an ability to stop profit margin leakage, room for improvement, and opportunities to grow. This might include a review of your procurement strategy to see whether it makes sense to diversify or consolidate your supply chain.
  • Revisit your capital structure—Businesses are typically supported by a mix of debt and equity. Assess the different options (senior, mezzanine, or convertible debt; preferred and common equity; and government loans and grants) and adapt your capital structure to better manage costs while also providing the resources to operate and grow.
  • Perform an 80/20 optimization of your business (customers, products/services, pricing)—Typically, 80% of an organization's profit often comes from about 20% of its customers and products. Look at your data to find out what customers or products are your biggest money makers. Consider the impact of no longer selling products or serving customers that provide little to no profit. Focusing your resources on servicing your most profitable products or services will increase margins.
  • Restructure the balance sheet—Now may be a good time to restructure your balance sheet to account for rising interest rates and debt servicing obligations, increased liabilities, the impact on profitability, and a potential decline in both enterprise and asset valuations.
  • Get professional advice—Experienced advisors can provide you with many different services to get your business back on the right track.

You need to strengthen and streamline your operations, we're here

We've helped a number of businesses in various industries to help manage their inflation risks and create value. Contact us to find out how we can help your business succeed.

Adam Brown, Partner, Value Creation Services

Matthew Marchand, Partner, Business Restructuring & Turnaround Services

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