How to Inflation-Proof Your Business

Inflation has reared its ugly head over the last couple of years, and while it seems to have settled down a bit in 2023, forecasters are predicting 2024 will be a wild ride.

Inflation reduces the purchasing power of your money; you pay more and get less. The impact can be severe, affecting supply chain, cash flow, and profit margins.

Costs of raw materials, supplies, and utilities are rising faster than you can increase prices. Employees want higher wages to handle their own inflation woes. The cost of borrowing keeps rising, making it difficult to finance investments in the business.

And consumers tend to spend less during times of increasing inflation.

How can you adapt your business and thrive during these crazy times?

  1. Employee retention is key. There is a labor shortage, and good people are hard to find. The cost of replacing employees is much higher than many employers realize; in some cases, the cost can be as much as 100% of an employee’s annual salary. Employees want higher wages since they are facing their own inflationary problems. But there are other ways to retain good employees outside of increasing wages; you can offer flexible work hours or additional paid time off. You can also think of simple things to increase morale, like bringing in lunch once a week.
  2. Look for local suppliers if you are experiencing supply chain backups. Try to diversify the number of suppliers you use and compare their pricing regularly.
  3. Review processes and look for ways to streamline and improve efficiency. Encourage feedback from employees, especially those who are most productive.
  4. Manage your inventory. While it is comforting to have a stockpile when your supply chain is still experiencing holdups, the cost of carrying too much inventory is high. Not only does it mean cash out of your business, but there is also the cost of warehousing and managing the inventory. You also run the risk of obsolescence.
  5. Review your pricing strategies. Raising prices must be carefully evaluated in terms of competitors’ pricing, strength of your customer base, and perceived value. Look for ways to increase the perceived value of your products/services to offset the effect of the increased prices.
  6. Update your marketing and advertising strategies. Look at advertising methods you have not used in the past and evaluate if they might be worth a try.

Break-Even Analysis – What and Why?

Break-even is the point when income matches expenses. Knowing your break-even point shows how much revenue you need to equal and surpass expenses. To determine your break-even point, you need to understand a few terms.

Fixed costs are the costs that do not change no matter how much revenue you earn. Items like rent, utilities, management and administrative wages, and insurances are considered fixed costs.

Variable costs are those that are directly related to the products or services you sell. They include raw materials, direct labor (manufacturing labor or service labor), and the cost of items purchased for resale.

Contribution Margin is calculated by subtracting variable costs from revenues.

Break-even = Fixed Costs/Contribution Margin

Below are three examples of break-even analysis for different types of business.

Manufacturing company:

Fixed costs                = $60,000 per month

Variable costs            = 30%

Sale price per item    = $50

Contribution margin = $50 – 30% = $50 – $15 = $35

Break-even                = 60,000/35

                                  = 1,715 items or $85,714.50 in sales

This company needs to sell 1,715 items per month at $50 each to break even.

Restaurant:

Fixed costs                    = $9,000 per month

Variable costs (food)     = 40%

Average bill per person = $50

Contribution margin     = $50 – 40% = $50 – $20 = $30

Break-even                    = $9,000/30

Break-even                    = 300

The restaurant must serve 300 people in a month to break even. That equals about 10 people per day.

Service provider:

Fixed costs                 = $4,000 per month

Variable costs (labor) = 50%

Sale price per hour    = $100

Contribution margin  = $100 – 50% = $50

Break-even                 = 4000/50

Break-even                 = 80 hours of services sold or $8,000

This service provider needs to sell 80 hours of services each month to break even.

Why is break-even analysis so important?

1. Knowing your break-even helps you determine if a business can be profitable. If you need to charge $100 per unit to cover your fixed and variable costs but competitors are charging an average of $60 per unit for similar items, you know you are not going to be successful with this set of circumstances. But if your products are better quality and justify the higher price, then it could work.

2. Determining your break-even forces you to consider all your variable and fixed costs. A manufacturer might be able to negotiate better prices for raw materials; a restaurant might consider other sources for food, you might need to reduce the number of employees, or you might need to shop around for lower insurance premiums.

3. Knowing your break-even point can help you discover the items/services that bring the highest profits. Doing a break-even analysis for the individual items you sell will show you where you make the most money. Sometimes it will tell you if you need to eliminate certain items or services.

4. Similarly, a break-even analysis will help you decide if a new product or service will be profitable.

5. Break-even analysis is necessary if you want to attract investors. This shows investors that you understand your business numbers and will help you substantiate any claims you make about profitability.

A break-even analysis should be done for every business at least once per year, along with a market analysis. Cost increases in materials, labor, rent, insurances are a given. Any needed sales price changes can be determined by looking at the break-even, along with considering competitors’ pricing.

A good accountant should be able to work with you on your break-even analysis. If your accountant does not provide one, ask for it!

The Business Plan

A Business Plan is a thorough description of your business, your business goals, and your plans to achieve those goals. A Business Plan is the most important, yet most overlooked, document you can prepare for your business.  Potential lenders or investors almost always request a Business Plan.  But if you are self-funded, you might be tempted to skip it.  Don’t!

Writing a good business plan will force you to think hard about all aspects of your business and identify the various factors that can make your business a success or a failure.

The elements of a good business plan should include the following:

Executive Summary

This is a one-page summary of the business plan. It should briefly describe the purpose of your business and the contents of the plan. The best way to write the Executive Summary is to do it last, after you have thought out and written the rest of the plan.

Business Description

Begin with the purpose of your business and your short-term and long-term goals. This should include a short description of your industry including the present outlook and future possibilities. Also provide information on the various markets in the industry as well as any new products or developments that will benefit or adversely affect your business.

Market Analysis

This is where you define your Target Market – who do you think will need/buy your products/services? Describe the current market trends for both your industry and your potential customers – where is the market expected to go and how will your company fit? Also include details about your potential customers – their ages, education, income levels, etc.

Competitive Analysis

Compare your company to the direct and indirect competitors in your market along with their strengths and weaknesses. Detail your strategies to differentiate your company from the them. List any barriers to entry that could deter potential future competitors.

Design and Development

Describe the products or services your business will provide. Detail the product’s design, show its development and where you are within the development stage, and your plans to bring the product to production. Indicate if you have or plan to acquire any copyrights, trademarks or patents.

Products and Services

Detail exactly what you are planning to create and sell, how long your products will last, and how they meet an existing need. If you are a manufacturer, describe your products and your manufacturing process. Include information about suppliers and availability of materials. If you are a wholesale distributor, describe your products and the supply chain. If you are a retailer, describe your sources of inventory and your inventory management plan. If you are a service provider, describe your services and what makes you qualified to provide them.

Marketing Plan

How do you plan to sell your products or services? Will you sell online, in stores, or via catalogs? Describe your pricing strategy and how it compares to your competition. Indicate how buyers will learn about your company and your products. Explain any advertising and networking plans as well as sales incentives or promotions you will offer.

Management and Administration

Describe the legal structure of your business – sole proprietor, limited liability company, or corporation – and why that structure is best for your company. List all the owners and/or officers and describe their strengths. Also list the managers and describe their responsibilities and abilities.

Funding Requirements

Provide a summary of your financial needs. How much funding do you need? Give a detailed list of how the funds will be used and your plans to repay those funds.

Financial

Insert financial projections here:

  1. Pro Forma Cash Flow Statement – this should show your expected cash inflows and outflows for at least the first year – three years would be better.
  2. Income Projection – a Pro Forma Income Statement should show your projected revenues and expenses for the next three years. Base future years on expected economic and industry trends.
  3. Projected Balance Sheet – what will your assets, liabilities, and net worth look like at the end of the next fiscal year.
  4. Break-Even Analysis – this will show how much revenue you need to generate to cover both your cost of goods sold and administrative expenses.

A good business plan is essential if you need outside funding, but it is invaluable in helping you crystalize your plans for making your company a success.

Fixed Assets

Fixed assets are items that are used in your business’s ongoing operations for longer than a year. These items should not be “expensed” or shown on the Profit and Loss Statement; instead they should be recorded on the Balance Sheet as assets. They are expensed over time through depreciation. Examples of Fixed Assets are:

  • Machinery and equipment
  • Furniture and fixtures
  • Vehicles
  • Computers and Software
  • Land
  • Buildings
  • Building Improvements
  • Leasehold Improvements

Fixed Assets are recorded on the Balance Sheet at the purchase price plus any installation costs needed.  Once a Fixed Asset is put into service, except for land, it begins to lose value. This loss in value is accounted for with Depreciation (for tangible assets) or Amortization (for intangible assets like software).  Depreciation and Amortization are non-cash expenses in that they are included in your Profit and Loss Statement even though there is no cash transaction.

Different Fixed Assets have different useful lives so are depreciated over different periods. There are a number of depreciation methods, but the two of the most common are:

  1. Straight-line depreciation is the simplest. Take the original cost of the Fixed Asset, subtract any expected Residual Value (if you think you will be able to sell the asset once you are no longer using it), and divide the result by the number of years you expect to use the asset.
    • For example, you purchase a computer for $2,000 and expect to use it for three years, after which you think you can sell it for $200. The annual Depreciation Expense will be $600.
    • ($2,000 – $200) / 3 = $600
  2. Unit of Production method us often used for machinery used in production. Take the asset cost less any residual value and divide that by the number of units of production expected from the machine. Then multiply the Per Unit Depreciation expense by the actual number of units produced during that period.
    • For example, you purchase a printing press to print flyers for $10,000 and expect to be able to sell it for $1,000 when you dispose of it. The press will be able to print 100,000 units over its useful life. The per unit of depreciation will be .09 (nine cents).
      • ($10,000 – $1,000) / 100,000 = .09
    • During the first full year of operation, you print 10,000 flyers. The depreciation expense for that year will be $900.

The IRS has rules for fixed assets and depreciation, and those rules can change. It is important to work with an accountant who understands the proper way to classify fixed assets and the most beneficial method of depreciation.

Choosing a Business Structure

There are several different legal structures in which you can form your business. The four main types are listed here:

Sole proprietor

A sole proprietor is someone who owns an unincorporated business alone.  Basically, you are your business—there is no separate business entity.  You are automatically considered a sole proprietor if you conduct business but don’t register as any other type of business structure. You are personally responsible for all liabilities of your business.

A business run as a sole proprietorship does not pay separate income tax. The income and deductions of the business are reported on a Schedule C, Profit or Loss from Business which is filed with your Form 1040 each year. You will also need to file Schedule SE, Self-Employment Tax. Additionally, you need to pay estimated taxes on a quarterly basis using Form 1040-ES, Estimated Tax for Individuals. Consult with a tax professional to determine the appropriate estimated tax payments.

Partnership

A partnership is an agreement between two or more people to participates in a business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

A partnership must report the business income, expenses, gains, and losses from operations on Form 1065, U.S. Return of Partnership Income, but does not pay income tax. Instead, the profits or losses are passed through to the partners, each of whom includes his or her share on his or her Form 1040. Additionally, each partner needs to file Schedule SE, Self-Employment Tax, and pay quarterly estimated income taxes.

There are two common kinds of partnerships: Limited Partnerships (LP) and Limited Liability Partnerships (LLP). Limited Partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also have limited control over the company. Profits are passed through to personal tax returns, and the general partner is the only one who must pay self-employment taxes.

Limited Liability Partnerships are similar to Limited Partnerships but give limited liability to every owner. An LLP protects each partner from debts against the partnership in that they aren’t held responsible for the actions of the other partners.

Limited Liability Company (LLC)

An LLC is a business entity separate from the owners, and the owners usually do not have personal liability in case of bankruptcy or lawsuits.  Owners of an LLC are called members; members of an LLC may be individuals, corporations, or other LLCs. Most states allow “single-member” LLCs, and there is not a maximum number of members.

Depending on the number of members and the business considerations, an LLC can be treated as either a corporation, a partnership, or as part of the LLC’s owners tax return (a disregarded entity). A single-member LLC is treated as a “disregarded entity” unless it files Form 8832 and elects to be treated as a corporation. An LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and elects to be treated as a corporation.

Corporation

A corporation is a separate entity from the owners, who are called shareholders. Corporations provide the strongest protection to its owners from personal liability, but the cost to form and maintain a corporation is higher than other structures.

Any profits of a corporation are taxed separately from the owners. A corporation must file a Form 1120, U.S. Corporation Income Tax Return. Any profits paid to shareholders are called dividends and shareholders must pay income tax on any dividends they take. The corporation does not get a tax deduction when it pays dividends, consequently shareholders face “double taxation.” Additionally, shareholders cannot deduct any losses of the corporation.

S Corporation

An S Corporation is a corporation that elects to pass the business income and deductions through to the shareholders for federal tax purposes. This allows S Corporations to avid the double taxation on corporation income. To qualify for S Corporation status, a corporation must meet the following requirements:

  • Be a domestic corporation
  • Shareholders cannot be partnerships, corporations or non-resident aliens
  • Have no more than 100 shareholders
  • Have only one class of stock

 

Deciding which business structure to use for your company can be confusing. Consult with a trusted business professional if you are not sure of the best structure for you.

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