It is no secret that inflation is wreaking havoc on Australian small business in 2022.

The cost of goods and services rose 2.1 per cent over the March 2022 quarter, lifting the annual inflation rate to 5.1 per cent and triggering a pre-election interest rate rise.

A combination of factors have contributed to this inflation, many of them related to COVID which saw huge cash handouts in stimulus packages, supply chain challenges, and labour shortages, combined with cheap debt due to historically low interest rates.

In some industries, such as construction, materials costs have gone up 100 per cent, according to Paul Groenendyk, a CPA and Director of Dee Why accounting firm, Mair, Mansfield and Co.

“Prices have increased for all businesses, both from a materials shortage perspective and in labour costs,” Paul says.

While Australia’s quarterly Wage Price Index is not announced until May 18, 2022, Paul says he doesn’t need the Index to know that wages are increasing.

“Just by looking at the businesses I deal with I can see there is quite a bit of movement. A lot of businesses are losing staff, and not just to competitors offering higher wages, but to different industries. There is definitely some truth to the great resignation,” he said, adding that the impact of this is exacerbated by a shortage of foreign workers.

How inflation quickly impacts business profit

For those businesses who operate on lower profit margin products sold at high volume, a 5 per cent increase in costs can quickly erode their profit margin, Paul says.

Giving the example of a business with a $1 million annual million turnover at 10 per cent net profit ($100,000), Paul explains how only a 5 per cent increase in costs will reduce that net profit to $55,000 and a 10 per cent increase will reduce it to $10,000.

“Now, more than ever, businesses must be acutely aware of their financials. You must deeply understand your business income and expenditure, both today and in a variety of forecasted scenarios, so you can adjust your pricing accordingly. You do not want to get to a point where you are not making a profit.”

Strategies to minimise risk

Raise your prices: This is the obvious response, however raising your prices carries the risk that customers who have grown accustomed to paying a lower price will take their business elsewhere or purchase less often.

Paul suggests clearly explaining to your customers that your costs have gone up and that you have absorbed this cost increase until now, but that you are unable to continue to do that and remain in business.

He also suggests considering a staggered price increase to minimise the shock, and encourages price rises to be considered and calculated to account for both your financials, and competition.

Avoid fixed price jobs: Pauls warns against fixed price jobs, especially in times of inflation. If you have a long job delivery window and your costs increase during that time, then you may lose money on that job.

Reduce inventory lines: You can look to reduce low-margin goods or services and focus on delivering those with higher margins. This is especially beneficial when you have a lack of staff, so they can focus their time on more profitable work.

Increase stock: If a product is seeing high inflation, buying and holding more stock can help increasing your competitiveness, or profit margin. Stockpiling critical supplies can also minimise the risk of disruption from supply chain issues.

Evaluate your supply chain risk: Consider establishing alternative supply chains and suppliers – both domestic and foreign.

Watch your debt: Be diligent on credit checks, credit limits, invoicing, and payment terms.