Measuring the impact of inflation on small businesses


It’s no secret that the pandemic has taken its toll on small business owners, but until now the true economic impact had not been measured. Biz2Credit recently released its results Small Business Inflation Study which analyzed the income and expenses of more than 140,000 U.S. small businesses from January 2019 to October 2022.

The Biz2Credit Small Business Inflation Study identified three distinct phases:

1. The pre-pandemic phase to Q1 2020.

2. The first waves of the COVID pandemic before mass vaccination in the first quarter of 2021, when both small business revenues and expenses plummeted.

3. The period of gradual, partial recovery of small businesses after revenue bottomed out in the first quarter of 2021 and extending into the second quarter of 2022. Inflation persisted through the third stage.

The analysis showed that pre-COVID, small business spending was virtually contained compared to revenue. However, in the post-vaccine recovery and inflation period, especially in 2021 and 2022, margins were significantly eroded. Small businesses have to work harder, have to sell more to reach the same level of prosperity. This is complicated by the reality that spending has risen significantly over the past year and a half.

The reasons are well documented: rising gas prices, supply chain issues and labor costs. Many companies can’t find labor, and when they do, costs are higher than in 2019. All of that leads to small businesses having a lower margin on each sale. Complicating the issue is that if an entrepreneur needs working capital, he will have to pay much higher interest rates than before the pandemic as the Federal Reserve continues to raise rates in an effort to curb inflation.

The Fed has raised interest rates several times in the past year. For most of the past decade, they were near zero. Financing costs more now than it has in a long time, and entrepreneurs need to take care of that reality. For the first time since 2008, entrepreneurs are facing interest rates of more than 10%, depending on the lender.

“I think there is no doubt that this has hurt small businesses and not only through declining consumer demand for products and services, but also by raising interest rates,” US said. Senator John Hickenlooper (D, CO) serves on the Senate Small Business and Entrepreneurship Committee.

“The loans that could get you through the slow periods have gotten a bit more expensive,” added Hickenlooper, a proponent of expanding access to capital for women- and minority-owned businesses and businesses in underserved areas by making fintechs a to play a greater role in SBA lending.

Hickenlooper said the Senate, for its part, has focused on the issues surrounding inflation and what can be done to curb it, as inflation is a barrier to small business growth.

Key Findings of the Small Business Inflation Study

· In the pre-vaccination COVID phase, average monthly small business expenses decreased by 21%, from nearly $14,000 in 2020-Q1 to just under $11,000 in 2020-Q3.

· The economic behavior of small businesses in the post-vaccination inflationary phase was very different from the pre-vaccination phase. In the pre-vaccination phase (Q1 through Q3 2020), small businesses implemented significant cost cutting despite declining revenues, with both dollar per spend transaction and number of transactions falling by 14% and 8%, respectively.

During the post-vaccine recovery (Q1 through Q3 2022), a period of high inflation, small businesses experienced severe cash flow pressures as they attempted to maintain business activity at a higher post-vaccine recovery level. For example, dollars per issue fell by 12%, while the number of transactions increased by 9%, offsetting the decline in the former. This change in behavior reflected the need to manage cash outflows by limiting individual cash outflows during a period of high inflation.

· During the period of highest inflation, average monthly expenses of small businesses decreased by 5%, from $11,401 in Q1 2022 to $10,884 in Q3 2022.

· As inflation accelerated, consumers also became increasingly stressed by rising prices. In the post-vaccine recovery, revenue increases outpaced inflation, but in the second quarter of 2022, revenue growth fell below the pace of quarterly inflation.

This may reflect a reduced capacity of small businesses to pass on cost increases to their customers (“pricing power”), with important implications for 2023.

The inflationary period is being evaluated in the context of the unique circumstances created by the COVID pandemic. After mass vaccination in the first quarter of 2021, the economy started to recover due to a combination of a strong labor market and the spending of savings by consumers and companies. However, the economy also faced pandemic restrictions in the global supply chain.

This first-of-its-kind study was based on transactional cash flow data from nearly 105 million small business cash inflow and cash outflow transactions on the Biz2Credit online marketplace. Unfortunately, the price spike came just as the economy was recovering from the first waves of the pandemic, posing new challenges for small businesses. Many of them are still in pain.

Prices in the US experienced a sustained increase starting in the summer of 2021, with inflation accelerating in mid-2022. Manufacturer price index (PPI), which measures the prices paid by businesses, grew in May 2022 at a peak of nearly 3% month-on-month and more than 20% from the previous year.

“The rise in prices continues to affect us. It’s hard to raise our prices. It’s mac & cheese; there’s only so much you sell a plate for,” Sarita Ekya exclaimed S’MACthe first restaurant in New York City dedicated exclusively to mac & cheese.

Influence of inflation on individual expenditure items

The study also looked at the impact of inflation on small business behavior for individual spending items, namely energy prices (gasoline and utility rates). Rapidly rising gasoline prices in 2022 have significantly damaged the transportation and storage industry, for which fuel is an essential input. Between Q1 2022 and Q2 2022 – when average gas prices increased on a quarterly basis from $3.78 per gallon to $4.60 per gallon – average expenses increased from $325 to $345 and later declined to $333 in Q3 2022, when average gas prices had fallen slightly to $4.19.

Despite the increased spending, gas volume fell from 87 gallons to 75 gallons as gas prices rose in 2Q 2022 and later climbed back to 80 gallons in 3Q 2022 as gas prices declined. Trucking companies had little choice but to fulfill customer orders without much leeway to react to changing gasoline prices.

“Inflation is the biggest challenge facing small businesses in 2023, and Biz2credit’s research shows the impact it’s having on small businesses. Entrepreneurs are struggling to prioritize costs and manage cash,” said Charles “Tee” Rowe, President and CEO, American SBDC. “With the current volatile economy, we encourage small businesses to visit their local Small Business Development Center (SBDC) for advice on creating a manageable path forward.”

Implications for small businesses in 2023

Inflation during the post-vaccine COVID period led to significant changes in small business operations. In 2023, significant uncertainty remains associated with continued inflation, additional spikes in gasoline prices, further rate hikes by the Federal Reserve, and weaker economic growth.

However, all is not doom and gloom. There have been signs that when the Federal Reserve’s Federal Open Market Committee (FOMC) meets for the first time this year on January 31 and February 1, the next rate hike may be smaller. After four consecutive 75 basis point increases, the Fed raised interest rates by half a point in December. Some analysts predict that the central bank could raise interest rates by 25 basis points this time around.

Regardless of the size of the next rate hike, the current economic climate underscores the need for careful cash flow management. Cash outflows must be well timed to match cash inflows from customer revenue. On the revenue side, small businesses need to gauge carefully when they have “pricing power,” the ability to pass cost increases on to customers without hurting demand too much.”

Small businesses should carefully assess whether their operations require additional financing to better manage cash flows and whether their projected cash flows can support borrowing. A disciplined historical track record in prudent cash flow management can be very helpful to companies looking to obtain funding from banks and banks online marketplacesshould they choose to request it.


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