Prices are rising. It is not just me experiencing a ‘heart moment’ at the supermarket checkout, or when buying petrol. Energy costs and their associated direct debits are also on the rise.
A quick look at why, and a quicker look at what you can do about it.
Why:
- Classic economic theory has “too much money chasing too few goods” as the cause of inflation. Governments around the world have printed money – which they have called quantitative easing –to assist people and businesses through the pandemic, encouraging people to stay at home rather than go out to work (and spread virus: this was important in 2020, not so much in a substantially vaccinated 2022)
- Too few goods: there are supply issues, especially with energy due to the sanctions imposed on Russia as a result of its barbaric invasion of Ukraine. For example the UK imported around 18% of its diesel from Russia in 2020: combined with Extinction Rebellion’s (a group demanding the end of fossil fuel use) blockading of oil terminals in the UK this means a shortage of diesel, queues at petrol stations, which causes people to fill up their tanks more, which further reduces supply …
- Its not just energy: similar patterns are emerging in food stuffs, plus cars and electrical goods which rely on computer chips – most products then.
Is this a problem? – It depends which economists you trust. Some who follow Modern Monetary Theory state that governments can print their way out of trouble. Inflation also reduces the real value of debt, making the long term servicing of government debt easier. Others regard money printing as a straight-line route to the issues of Weimar Germany in the 30s or Zimbabwe in the 1990s.
But put it this way: if you had £1000 (or dollars, Euros, Rials etc) in the bank in January, and by the end of this year saw you had only £920 – you would feel robbed. Yet the effect of inflation is that it reduces what your £1000 will buy you: at 8% it will only buy you £920 worth of goods at the end of the year. As long as you can still buy goods, you don’t feel so robbed.
This also assumes the rate really is 8%. Remember this is an average, and there is some debate about the basket of goods that produces this measure. Some prices are increasing far more.
What can we do?
(This is a very simplified approach…)
- Check your prices. You probably need to increase them – by around the 8% mentioned (the forecast for inflation in the UK) if you haven’t already. If you are one of my clients, you may have noticed this.
- Survive for a few more decades. We have been here before. When studying my Economics ‘A’ Level inflation was around 14%. In my very early banking days I was told stories of people having 2 pay rises a year so their pay would keep up: it also caused the price rises of course.
At 8% or so, for a while, we will probably survive. Compared to some – especially Ukraine – this is not what you call a problem.
But if you just sit, watch and do nothing, it will become one.
Buzzword of the Week – Weighted Average Cost of Capital (WACC)
Definition – Represents a firm’s average cost of capital from all sources, including share capital (equity), bonds, and other forms of debt. It is a common way to determine required rate of return because it expresses, in a single number, the return that both bondholders and shareholders demand in order to provide the company with capital. It will likely be higher if its stock is relatively volatile because investors will demand greater returns, or if its debt is seen as risky.
WACC is calculated by multiplying the cost of each capital source (debt and equity) by its relevant weight and then adding the products together.
Suppose that a company obtained $1,000,000 in debt financing @ 8% and $4,000,000 in equity financing @ 12%. E/V would equal 8 x 0.8 ($4,000,000 ÷ $5,000,000 of total capital) and D/V would equal 12 x 0.2 ($1,000,000 ÷ $5,000,000 of total capital). Add 6.4 to 2.4 = 8.8% WACC.
Alternate View Classic business school MBA fare. Fine in theory but riddled with doubt in practice because of the nebulous nature of cost of equity. You should realistically also allow a post-tax calculation of the debt costs too. Does any company/corporation really know what its shareholder/stockholders expect or demand as return? The 5 return also is easy to calculate as a dividend but again tax clouds the issue. Yet most capital in the 2020s is debt anyway because of low interest rates and the tax regime – cost of debt calculation is easier and more certain.
Coming Up…
Using Financial KPIs to grow your business – a free webinar in association with Qatar Skills Academy Wednesday 27th April 9.30-10.45am UK/11.30am-1245pm Qatar sign up at https://teams.microsoft.com/registration/pos1uhf_HEG1p5cawx-1rg,q67s-XdJSEWjO5juxB7iug,SOHA5PiAnEiQJCWVMm6K2A,yCniJE8S-EurMOOTX0fONg,zF_8l_1Puka3aOo8X4rflQ,q1SnnVr380qYlAiEglhkog?mode=read&tenantId=ba358ba6-ff17-411c-b5a7-971ac31fb5ae
This is not business but: Stratford Musical Theatre Company present Legally Blonde at the Stratford Playhouse from May 4th-7th. A musical story of a woman’s struggle against sexism in the legal profession – its funny too! Tickets from https://www.ticketsource.co.uk/stratfordplayhouse2/legally-blonde-stratford-musical-theatre-company/e-rxqqrz
Phil Ingle Associates – I make understanding business easier. To improve you need to become better at what you do: I enable you to become better at running your business. I specialize in training and coaching you in three areas which are crucial for any business: finance, negotiation, & communication. Can I help you? Check my schedule here https://calendly.com/philingle/30min-1 and find a slot which suits you