Actions for finance teams to mitigate the effects of high inflation

Inflation may be decreasing in some economies, but it remains at high levels.

Although some businesses may be in a better position to weather inflationary storms — none can escape them.

In 2022 almost half the world experienced double-digit inflation. At the end of 2022, inflation was at 6.5% in the US, 10.5% in the UK, and 9.2% in the euro area. Although in these three economies inflation rates fell slightly at the end of the year, they are still well above the UK, US, and European central bank targets of 2%.

In mid-2022 in the UK, the Federation of Small Businesses warned that 500,000 SMEs could become insolvent because of rising costs driven by inflation. Similarly, an October 2022 survey by UKHospitality, the British Beer and Pub Association, the British Institute of Innkeeping, and Hospitality Ulster indicated that a third of UK hospitality businesses were at risk of business failure due to inflation.

In a US survey of 1,000 SMEs in mid-2022, 65% of small businesses said it was "very likely" or "likely" they would cease trading if inflation continued at its high rate. Meanwhile, across the EU, it was reported that 100,000 companies in Italy and 150,000 SMEs in France were at risk of insolvency due to inflation. In Poland, it was reported in October 2022 there had already been 104,300 corporate insolvency applications, a rise of 25.8% compared with 2021.

However, finance teams can take actions to help support their businesses in high inflationary environments. Recently, AICPA & CIMA, together as the Association of International Certified Professional Accountants, released an inflation report based on interviews with global finance leaders that details how finance teams are supporting their businesses during these times.

Scenario planning

According to finance leaders, scenario planning is the main tool used to combat inflation.

Good scenario planning from the board level down to the operational level means that finance teams are able to show the board and management inflation's impacts, including how much inflation alone is driving up costs.

A good scenario plan should help a finance team ask the "what if" questions on inflation. Scenario planning is also applicable in business functions including strategy, investment activities, and sustainability planning and reporting, among others.

Good data and data skills are necessary for a good scenario plan. Not all data needs to be quantitative: Expert opinions and differing views can help make informative and robust scenario plans. These views can be formed by looking at what is happening in different economies, markets, and sectors and considering how economic, geopolitical, and policy responses can impact inflation and the business.

One business described how it was using scenario plans to mitigate against inflation:

"…. as part of [the quarterly] board meeting, there were [a] significant number of scenarios run, and [additionally] they were being updated about every two to three weeks [including] here's what the baseline scenario would be if we didn't have inflation. [We] ran a baseline so that we could run a comparison for the board, to truly isolate what are the true inflationary costs. Versus what? What is the increase [in costs] due to the growth of the business? [Then] we've run what we'll call a low-probability scenario, a medium-probability scenario, and then a [high]-probability scenario using different rates of inflation … rates really on a regional basis."

The CGMA scenario planning toolkit can help you develop your own scenario planning.

Stress-testing

Stress-testing is linked to scenario planning. Stress-testing the different scenarios, wider business strategy, financial plans, and business model is key in an inflationary environment. As part of this stress-testing, finance teams should make assumptions based on extremes and test combinations of assumptions — highly unlikely scenarios may occur.

One finance leader in the UK's social housing sector described these questions to ask as part of this process:

• What if rents were to be frozen?
• What if no inflation is applied at all?
• What if inflation was to peak at xx%?
• What if inflation reduces to xx% in the next few years?
• What if interest rates go up?

By conducting the stress-testing of possible and highly likely inflationary events and their outcomes on the business, finance can get a better and more holistic understanding of the vulnerabilities and the appropriate responses to them.

Cost control

Different businesses and sectors will have varying approaches to cost control.

Company spending should be geared towards delivery of business strategy and goals. One finance leader in the services sector described cutting out unneeded spend by reviewing expenses and travel budget and sourcing staff internationally where applicable to reduce costs.

Implementing a strategy for managing costs should be an immediate priority if you do not already have one. Cost management can be thought about in three ways:

• Efficiency: The ratio of outputs to inputs — ie, "doing more with less".
• Economy: Acquiring necessary inputs at lower costs.
• Effectiveness: Ensuring that all inputs are necessary and complete for outputs.

Cost control should be embedded across the whole organisation and not just in finance. Finance should be the leader, however, in embedding this in culture and strategy.

The CGMA Cost Transformation Tool can help finance leaders with cost management.

Supply chain management

Finance leaders also reported looking at their supply chains to find cheaper suppliers and build more supply chain resilience. This action can help mitigate against inflation.

Here are some simple steps finance teams can take to help manage their supply chains:

• Understand the strengths and weaknesses in your supply chain. You cannot fix problems you don't understand. Speak with key teams and individuals within your organisation to understand and evaluate your supply chain.
• Resilience-test your supply chains.
• Create emergency plans.
• Collaborate, including by creating partnerships, strategic alliances, and networks. Different forms of collaboration may be adopted at different points in the supply chain.
• Consider inventory stockpiling.
• Put systems in place to spot challenges early.

Pricing

Many finance leaders reported they were unable to "eat all the costs" caused by inflation themselves. This meant they had to raise prices to remain financially viable and competitive.

However, this is often not the first course of action for businesses, and many use cost control and efficiency to try and limit passing on costs as much as possible. Before raising prices, businesses should consider the steps below to find their ideal price point:

• Ask initial questions. What are your competitors doing in terms of prices? What is your sector doing? What is your market position? How loyal are your customers? How long ago did you last raise prices? How much can you raise the price to retain market share? How much are customers willing to pay? The answers to these questions can help inform your pricing strategy going forward.
• Evaluate how customer behaviour would change. Once you have decided to raise prices, it is important to work out how these increases will affect your customers and potential customer base. Scenario planning around these different options can help.
• Track these increases. This is to understand the effect price increases have on your sales volume and gross revenue. If price increases are set at the right levels, and customer numbers and orders have not dropped or dropped significantly, then the increases are helping maintain financial viability and sustainability.

Efficiency

Some finance leaders said they were not just using efficiency techniques as a cost-cutting exercise but as an approach to find new ways to become more productive and add value to the business.

Others used a focus on efficiency as a way to demonstrate to customers that price increases were due to inflation and not business waste.

Other methods to mitigate the effects of inflation

In addition to efficiency, scenario planning, and the other suggested strategies, finance teams reported using other methods to mitigate against inflation:

• Hedging. One way business can try to get some certainty or limit potential risks in the medium to longer term on key commodities prices is by hedging with either forward contracts or options.
• Forecasting. Conducting rolling forecasts every quarter for the coming 12 months and/or longer and forecasting up to three years in advance can help you predict the longer-term effects of inflation. Using different rolling forecasts for different business units and accounts can enable them to more accurately forecast inflation on different products and services.
• Process mapping. Process mapping helps provide a framework that shows all the business's core processes and the relationships between each step and the key decision points. Through process mapping, finance teams can get a clear overview of processes within their business; identify areas for improvements or cost savings; identify opportunities and risk areas; improve communication between teams and different parts of the business; and, if done the right way, open new ways of working.
• Interest rate locks. Locking in debt interest payments to mitigate inflation can help if a business relies on debt to make an investment or secure stock or if it uses debt as a means to transform the business. Focus group participants described how this can help provide certainty and mitigate rising interest rate risks.
• Long-term financial planning. Long-term financial planning can help businesses identify where they can smooth out the effects of inflation. For example, one focus group participant in the social housing sector said they may be able to push back improvement programmes to their homes until inflation is better under control, but they could only make those decisions when taking a long-term view.

Inflation may be decreasing currently in some economies, but it could easily start to rise again and, by historic standards, inflation is still high. Inflation is likely to continue to be a significant factor throughout 2023, and finance professionals will need to be able to support their businesses with this challenge. The steps outlined in this article will help them with that and also ensure businesses are in a good position when inflationary pressures ease.

— Ross Archer is director–Public Policy at AICPA & CIMA, together as the Association of International Certified Professional Accountants. To comment on this article or to suggest an idea for another article, contact Oliver Rowe at Oliver.Rowe@aicpa-cima.com.