As hints of inflation loom, CFOs offer 5 strategies businesses can take to limit harm

As leaders are navigating their businesses through the COVID-19 crisis, they have a new threat looming over their recovery — rapidly rising prices.

The U.S. inflation level hit 5% in May, its highest rate in over a decade. And with many economists expecting the surge to persist, investors and consumers have become jittery.

Back to the basics

Simply put, inflation is the overall increase in the price of goods and services. It is measured by the proportional changes over time in the Consumer Price Index, prepared on a monthly basis by the U.S. Bureau of Labor Statistics. 

Businesses, consumers and investors are all impacted by an uptick in prices. From eroding purchasing power to affecting fixed-asset values, rising inflation causes companies to adjust their pricing of goods, services and so on to ensure viability.

Breaking down the figures and fears

The CPI jumped by 5% in the 12 months through May, marking the sharpest year-over-year increase since August 2008 and exceeding the 4.7% hike anticipated by economists, according to the early June 2021 economic release of the BLS. 

Core CPI, which excludes volatile prices of food and energy, rose 3.8% over the last 12 months, also overshooting the projected 3.5% increase. 

Elevated inflation rates coupled with months of record-high government financial aid and the Fed’s ultra-low interest rate policies aimed at offsetting the COVID-19 crisis have raised concerns for inflation to get a lot worse.

This has made many investors worried about a sudden shift in the federal monetary policy to curb inflationary damage, in which an increased federal funds rate could trigger an economic recession and widespread unemployment.

Be ready

Though Fed officials have a benign outlook on accelerating inflation and are confident about the spike being just a passing phase of post-pandemic recovery, several economists and investment strategists across the U.S. are predicting higher consumer prices to persist and suggesting businesses gird themselves against the inflation menace. 

Besides upsetting the relationship among a company and its suppliers, workers, customers, lenders and other stakeholders, aggressive prices often make businesses fall prey to the vicious inflation cycle and make decisions detrimental to their financial health.

Here are five strategies that CFOS can consider using to ward off profit erosion by rising costs.

• Issue debt

With the yield on the benchmark 10-year Treasury note being about 1.5% (as of June 23, 2021), economists advise financial leaders to take advantage of low borrowing costs and consider selling bonds.

As inflation will gradually reduce the real cost of debt service, extending debt maturity as much as possible and considering debt issuance now would be a good idea for businesses.

However, CFOs should not go overboard with issuing debt to raise cash, and in no way put themselves in a position where they can’t repay the investors.

• Hedge the weakening dollar 

For companies that are heavily dependent on imports, a depreciating U.S. dollar can create havoc.

To keep a check on the increasing costs resulting from a fall in the value of a dollar, CFOs of such firms should consider using a currency swap or similar financial tool.

While doing so, the financial manager should ensure that the other currency is not subject to a similar risk of inflation. Also, they should also be extra careful about overall transaction costs.

•  Cushion your company’s portfolio

At this time, it is pertinent that CFOs restructure their company’s investment portfolios and consider allocating a portion of investments into inflation buffers such as government’s inflation-indexed bonds — Treasury inflation-protected securities, gold or exchange-traded funds.

Though this wouldn’t help everyone reap excellent returns in an economic bust, diversifying your portfolio will limit losses resulting from looming market volatility.

• Go long with inventories 

With inflation expected to get more aggressive, businesses should watch their margins carefully. 

CFOs should consider stocking up their inventories before supplier prices shoot up. But weigh the expected price rise of goods and services against the cost of financing and carrying that extra inventory before making the decision.

However, companies should avoid overstocking and not jeopardize cash reserves when buying inventory ahead.

• Recall the pandemic lessons

The pandemic crisis underscored the importance of agility and resilience to businesses across the economy. To survive bouts of inflation and instability, many companies worked to maximize their agility, quickly adapting to the changing environment while maintaining strengths such as a solid balance sheet. 

Additionally, many financial leaders discarded their reliance on historical data and switched to using more short-term and real-time data as well as data analytics to stay ahead of COVID-19 induced challenges.