Silvan Mifsud is director of Advisory at EMCS Tax & Advisory
The message from the European Central Bank (ECB) is very clear. Christine Lagarde has been reported as saying that further interest rate rises from the ECB are very likely as inflation is a monster that needs to be knocked on the head. The ECB is trying to achieve a balance between not breaking the economy while reducing inflation. Indications so far are that European economies are resilient where employment is robust and unemployment is the lowest it has ever been. While Eurozone headline inflation has fallen for four months after hitting a record 10.6% in October 2022, dropping to 8.5% in February, mainly because of decelerating energy prices, core inflation, which excludes energy and food, hit a new record high of 5.6% in February.
So what does this mean for businesses? Rising prices and interest rates don’t just mean higher borrowing costs. They can affect almost every aspect of your business, including reduced sales. As prices increase consumer-spending could drop while higher prices would likely mean higher costs for stock and raw materials, potentially putting profit margins under pressure. Moreover, with a tight labour market and inflation rising, some businesses may be under pressure to increase wages to attract and keep the staff they need.
So what is the key take-out for business owners and leaders in such an evolving situation? Keep watching the numbers in your business, including monthly sales revenue, supplier costs, salaries and margins, and be prepared to take action if things change. You need to be on the ball like never before.
How can businesses be prepared? The first port of call is increasing your efficiency and lowering your expenses. So taking a fresh look at expenses is advisable to see if your business can find new opportunities to save, especially on fixed overheads that your business pays every month. Also, review your pricing and margins. Increasing your prices is the quickest and easiest way to improve your margins and profitability. It might be that presently customers may be more willing to accept price adjustments with costs rising across the economy than when inflation was low. However, before you just increase prices across the board, makes sure you know the gross profit margin for each of your products or services and the contribution each of these are delivering after considering any variable overhead. Revise your strategy as whether you ought to increase the profitability of low-margin activities or focus exclusively on higher-margin products and services.
It will also be useful for businesses to assess their “war chest” that is, their working capital buffer. Having extra working capital is a great way to protect your business from unexpected expenses and cost increases, so you have the needed cashflow to pay the bills while you adjust. It could be wise to re-assess things by making sure that your clients are respecting credit terms, negotiating better credit terms with your suppliers and possibly availing yourself of a bank overdraft or a larger bank overdraft, if possible.
The final message is simple. You need to put your act together, prepare your business for a likely period of lower sales and higher costs and make sure that you are on the ball at all times. Businesses need a constant reality check, more than ever before.