Small Business Basics: What is Inflation

Small business owners often experience inflation firsthand: Your suppliers may be charging more, there's pressure to raise wages to keep pace with the rising cost of living, borrowing for expansion is becoming more difficult, and health insurance rates may be increasing. For founders and HR leaders, it can affect everything, from hiring budgets to benefits planning. This guide breaks down what inflation means for your business and provides concrete strategies to manage rising costs while supporting your team.

What Inflation Really Means

Inflation refers to prices rising across the board over time, making your money stretch less far than it used to. If inflation is running at 3% per year, something that cost you $100 last year will cost $103 this year. And it keeps adding up. For business owners, inflation can mean real pressure on everything from your operating budget to what you can afford to pay people to how much you need to charge customers.

What Causes Inflation?

Understanding where inflation comes from helps you predict what might get more expensive next and plan. Keep in mind the three main sources of inflation:

1. High Demand, Low Supply: When people have money to spend, and there aren't enough products or services to go around, prices go up. The same phenomenon plays out in the job market: when everyone's competing for the same talented employees, salaries climb.

2. Rising Business Costs: When the basics get more expensive (such as materials or shipping), you're either stuck with those costs or passing them along to customers. For service businesses, this usually means higher wages.

3. The Expectation Cycle: When everyone expects prices to keep rising, employees ask for bigger raises to keep up, and businesses raise prices to cover those raises.

What are the Different Types of Inflation?

There are five main types of inflation, ranging from deflation to hyperinflation. Many small businesses in the U.S. are currently facing moderate to high inflation, naming it as one of their biggest concerns(opens in a new tab). How should you respond? It usually depends on the type of inflation. Here are some examples:

How Inflation Can Affect Your Businesses

Rising inflation doesn't just squeeze your business—it strains your employees. If inflation is running at 5% and you give a 3% raise, your employees are actually losing purchasing power. Matching raises with inflation can help you retain your top talent. Then there's the benefits side of things. Health insurance premiums often run higher than regular inflation(opens in a new tab). Your total compensation costs, including salary and benefits, can grow faster than you'd expect, even when you've budgeted carefully.

Profit margins can take a hit, too. When your suppliers raise prices but you can't easily pass those increases along to customers, your margins get squeezed from both sides. Inflation can also affect your cash flow and make borrowing more expensive, potentially throwing a wrench into your expansion plans.

Ways to Measure Inflation

Several indicators provide insight into inflation trends. It's worth checking them monthly, especially the ones that matter most to your business. You can use the Consumer Price Index (CPI) for cost-of-living adjustments and the Employment Cost Index (ECI) to benchmark your compensation. Here's a list of the indicators:

• Consumer Price Index (CPI): It tracks what typical consumers pay for a basket of everyday goods and services.

• Core Personal Consumption Expenditures (PCE): The Federal Reserve closely watches this metric because it removes volatile components such as food and energy prices. It helps predict interest rate trends.

• Producer Price Index (PPI): It tracks what businesses pay for supplies and materials and serves as an early warning system for potential price increases.

• Employment Cost Index (ECI): It monitors wage and benefit trends across the economy and is useful for HR planning.

How Small Businesses Can Handle Inflation

There's usually more than one route for businesses to navigate inflation. It often depends on your industry and the size of your business. You can get scrappy by tweaking products or services, reducing waste, renegotiating supplier contracts, and ensuring that your business runs as efficiently as possible. Some businesses ask for upfront deposits to improve cash flow and implement value-based pricing or gradual price increases.

With health-insurance premiums continuing to rise, you can consider switching to high-deductible plans or adjusting how much the company and employees contribute to keep benefits competitive without breaking the bank. You could additionally add fringe benefits, such as remote work flexibility and professional development budgets, to round out compensation packages and attract talent.

Managing Inflation and Streamlining HR with Justworks

By understanding the impact of inflation on your business and actively monitoring key indicators, you can make proactive decisions that protect your team and your business. Rising costs may drive you to become creative about compensation, benefits, onboarding, and operations. The right tools can help.

Modern payroll services let you model different scenarios and implement consistent cost-of-living adjustments. For growing companies, international payroll solutions provide access to global talent markets where costs may differ significantly. Get started with Justworks today.