Many business owners would just look at inflation in terms of the standard published rate, such as the CPI (Consumer Price Index), and feel on top of things if they do an equal or greater price increase this year. But this article is going to show you how inflation specifically impacts your business and help you understand what actions you can take to protect your business.
There are three main categories of inflation that impact your business: Direct materials costs, overhead costs, and labor costs. Let’s consider each in turn.
Construction materials or whatever specific products you need to do your work do not move in sync with the overall inflation rate. Cost can move up or down sharply related to supply chain issues, shortages of specific commodities, or tariffs on specific items. If just a few key items drive most of your cost of materials, you can simply monitor the price of those items closely and adjust immediately. If you buy a lot of different items depending on the nature of the job, then keeping track of everything can get complicated. The indicator to watch is your gross profit margin. That’s the percentage of your revenue that’s left over after you pay for your materials. It is critical that you adjust your pricing regularly so that your gross profit margin stays roughly the same.
For simplicity you can think of overhead costs as all the other miscellaneous cost of doing business. This would include all your costs of facilities, office supplies, fuel, credit card processing, insurance, and more. If you are basically buying the same stuff as last year, you could just divide your current period expenses by the amount of your prior year expenses and find out the percentage that this went up for you. If you want to keep it simple, this is where it makes the most sense to apply the overall inflation rate to estimate how much this is going up.
Now labor cost is where inflation gets really interesting for small business owners. Because whether you’re paying attention or not, payrates keep changing in your industry. It’s not good enough to give out only cost of living raises each year. And it’s definitely not good enough to base it on what the pay rates were last time you worked for someone else. Sure, every employer should give regular raises, and they know that will push up their costs. But if your pay rates aren’t keeping up with the local market, you will constantly struggle to recruit employees and you will eventually lose some of your best team members. Generally speaking labor costs are rising faster than other costs for a few reasons. The biggest reason is that baby boomers are continuing to retire. But attitudes towards college education versus skilled trades have caused ongoing labor shortages that drive up costs. Young workers also have strong preferences for jobs that are off nights and weekends. This makes recruiting extremely challenging for restaurants or round the clock health care positions. While baby boomers expected to pay their dues, age old traditions like 65-hour work weeks in tax season have become a very hard sell. I can pretty much guarantee that the standard inflation rate is lower than the pace of rising wages if you are in a hands-on business like auto-repair, childcare, or HVAC. In addition to these nationwide factors, areas that are experiencing rapid population growth such as Huntsville, Alabama also experience more labor shortages and faster rising wages. There is a silver lining though because expanding demand equals greater opportunity for well-run businesses.
Here is your action plan for dealing with rising wages:
1. If the factors above describe the jobs in your industry, estimate that labor cost may be rising 2-3% faster than general inflation.
2. Make a point to find out what local competitors are paying. Look at Indeed and other job posts. Start checking salary websites every quarter and track how the numbers change more than just the absolute values (which can vary greatly by location and skill level). Join industry groups that share this data with members.
3. Make sure that prices are going up enough that on-the-job-labor is still the same percentage of your revenue.
4. When you go to recruit your next employee, make sure that you are paying competitive rates. Sometimes business owners convince themselves that qualified employees don’t exist, but the truth is, they just aren’t willing to work for the pay you posted.
5. Make sure that your existing employees are paid fairly. It’s critical to take care of your best employees. The hidden cost of employee turnover causes enormous lost productivity. Now, the simplest solution is to stay on track with annual raises. But providing extra compensation in the form of incentives that reward behavior that helps the business can be even more effective (See our article Beyond the Paycheck: Why Non-Cash Methods Are Essential for Motivating Employees). Make sure to share the additional profits too. If an employee can get above average results, they should earn above average pay.
How inflation impacts your own compensation from the business.
Many business owners lose out to inflation because they forget that the value a dollar actually changes every year. Let’s just say for example that you had a household income of 100K last year. You raised your prices enough to cover rising costs of materials and overhead. You paid enough to retain your team. Many business owners breathe a sigh of relief if they take home the same dollar amount they did last year. But inflation is also happening to you personally. You see it at the grocery store and when you go to renew your insurance coverage. What can sneak up on you is rising housing prices, healthcare costs, and skyrocketing tuition rates. Many experts suggest that the published inflation rate is the bare minimum of what you night need to maintain an equal standard of living. So aim to keep your take home pay rising each year and try to keep your net profit margin at a steady or rising percentage of revenue. Finally, remember that when you hold high personal or business balances in uninvested cash or in savings accounts with minimal returns, it is easy to lose to inflation. Work with an investment professional to keep your money working for you instead of fading away.
So there it is. Inflation in the real world is more than a standard percentage that applies equally to everyone. It shows up in the specific costs that drive your business: materials, overhead, and labor. The key is to watch the right indicators. Protect your gross profit margin when materials costs change. Track your overhead and adjust as needed. Stay aware of the real labor market so you can recruit and retain a strong team.
Businesses that understand their numbers and adjust quickly are usually the ones that come out ahead. Keep your pricing, wages, and personal compensation moving in the right direction. When you stay disciplined about margins and profitability, inflation becomes something you manage—not something that quietly eats away at your business.