What can UK small businesses do to fight back against inflation?

Louise Southall, economist at Xero, looks at the challenge of soaring prices
Louise Southall
An arrow representing inflation smashes a shopping trolley

It’s been over a decade since small businesses had to concern themselves with the issue of inflation. Even when the first price rises started to appear last year, many economic commentators thought it would be short-lived – a symptom of pressure easing after the pandemic.

Unfortunately, this wasn’t the case. As a result, central banks have started raising interest rates across the world. While rate rises can be challenging for small businesses that have debts, the impact of inflation is likely to be worse as owners try to remain profitable in an environment of rising costs and a significant cost of living crisis.

This isn’t just happening in the UK. Inflation is impacting all major economies, with consumer prices in the OECD area, the 38 countries in Europe, North America and the Pacific, rising by 8.8% year-on-year in March 2022, compared with just 2.4% in March 2021.

This was the largest year-on-year increase since October 1988, creating huge pressure on businesses everywhere. Here, we outline some of the core problems facing owners and offer advice on how they can alleviate the pressure on them.

Confronting the challenge

Inflation impacts small businesses in many ways. While the cost of stock and currency fluctuates regularly, they are usually beholden to prices set by suppliers for overhead costs such as energy, fuel, rent and stock. At the same time, there is pressure on cash flow due to the issue of late payments, delayed on average by 8.8 days past the agreed terms.

Employees are also demanding higher wages to meet the rising cost of living. Meanwhile, small businesses are facing strong competition for the small pool of available staff, which is also pushing up wages and other payroll costs.

All this pressure is adding up. Our recent survey found that small business owners are still recovering mentally from the stress of the Covid-19 pandemic. Meanwhile, only 15% of owners felt their wellbeing was being supported enough by the government.

Responding to the crisis

In this context, it’s crucial for small business owners to work with their trusted advisors to maintain profitability. Raising prices carries risk – when customers have come to expect only incremental increases, lifting them by too much could force a loyal base to look elsewhere. Alternatively, if businesses don't increase them enough, profit margins will shrink, which may not be sustainable.

But those customers are facing their own rising cost of living pressures. With real wages – nominal wages less inflation – falling in the UK, consumers cannot afford to spend the same amount on goods and services as they used to. This means inflation is hitting small businesses twice. They are dealing with rising costs and their potential customers have tighter budgets.

There are some positive signs, however, that small businesses are navigating this challenging period. The latest Xero Small Business Index data shows sales rose 14.3% year-on-year in May 2022 - the 15th consecutive month of double digit sales growth.

While we wait with bated breath for central banks to act and get inflation back under control as quickly as possible, the government must also play a role to ease the impact of rising cost of living on the economy, including on small businesses.

While some initiatives have already been put in place, there is more that can be done. For example, the government could and should create appropriate incentives for large businesses to pay their suppliers on time, and impose stricter penalties if payments are late.

In the meantime, it’s vital that small businesses stay across their finances and work closely with their trusted financial advisors to make the right cost and price-related decisions that will allow them to stay profitable. Finding ways to cut back on expenses will be crucial, for instance, looking at ways to re-evaluate and optimise the ordering of supplies to help keep last minute costs down, or expanding the supply network to find services at competitive costs.

There is no all-encompassing solution to what is a very global problem, but by taking some crucial steps, small businesses can put themselves in the best position to overcome the current challenges and set themselves up to thrive in the future.  

Written by
Louise Southall
Economist at Xero
July 4, 2022