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Inflation and recession – what they mean for smaller businesses

Inflation and recessions can significantly impact smaller businesses, including interest rate increases, a fall in consumer demand, and pressure from employees for salary rises.

Find out more in our guide.

 

Inflation is the term used to describe the rate of increase in prices during a specific period.

It is calculated using the Consumer Prices Index (CPI), a monthly check by the Office for National Statistics of the cost of over 700 things people regularly buy.

To calculate the inflation rate, the cost of the 'basket' of goods and services is compared to what it was a year ago.

Low and stable inflation is good for the economy, and even increases can be helpful in some circumstances.

However, if it gets too high, it can be economically damaging.

High inflation can impact businesses in several ways:

  • with an increased cost of living, consumers have less money to spend which can lead to reduced sales for a business
  • employers may experience increased demands for pay rises as staff face higher costs during periods of inflation
  • businesses that export products abroad may see a fall in sales because inflation means their prices are higher compared to competitors in other countries
  • businesses may find it harder to access funding as high inflation usually leads to increased interest rates which raises the cost of borrowing.
  • not all companies are impacted as hard by high inflation; some businesses, particularly those selling luxury products, can pass the extra costs on to customers by raising prices.

High inflation plays a significant role in slowing down the economy, which can then lead to a recession.

With high costs and wages often not keeping up with the level of inflation, consumers are hit in their pockets and are less likely to make purchases beyond necessities.

This impacts business sales and can lead to cost-cutting, reduced investment, and staff redundancies.

Interest rates tend to rise when inflation is high, leading to an increase in the cost of borrowing for both consumers and businesses, impacting spending and investments.

A recession is a temporary period of economic activity.

In the UK, a recession occurs when gross domestic product (GDP) declines during two successive three-month periods, known as quarters.

The last UK recession began in August 2020, following two periods of GDP decline due to the Coronavirus pandemic.

Before that, there was a significant recession in 2008 during the global financial crisis which continued for five quarters

A recession can impact businesses in several ways:

  1. profits can be reduced due to a reduction in consumer spending. This means companies need to cut or manage costs which can lead to investment being cut and staff redundancies; during the 2008 recession, unemployment reached 10%
  2. lenders often tighten their criteria for assessing funding applications during a recession, making it harder for businesses to access finance. On the upside, interest rates tend to be low during a recession, though this is not always the case
  3. with a recession impacting most companies, it can cause an increase in late payments, which may leave the company unable to pay its own suppliers.

Businesses can take action to tackle the effects of inflation and recession, including:

Businesses can assess existing costs and consider ways to minimise them.

That could be by reviewing subscriptions and whether they are still required, renegotiating better prices for services, sourcing cheaper supplies, or cutting travel costs by switching to more online meetings.

It costs more to attract new customers than to keep existing ones, particularly during an economic downturn when people watch their spending.

Focus on providing excellent service to your current customers to maintain their loyalty.

You could introduce loyalty schemes that provide product or service discounts and offer payment plans to help customers spend the cost of buying.

If you have a viable business with good long-term growth prospects, consider securing funding through a loan or equity investment.

Although inflation can lead to a higher cost of borrowing, interest rates tend to be lower during a recession.

 

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Finance Hub guidance and information

Reference to any organisation, business and event on this page does not constitute an endorsement or recommendation from the British Business Bank or the UK Government. Whilst we make reasonable efforts to keep the information on this page up to date, we do not guarantee or warrant (implied or otherwise) that it is current, accurate or complete. The information is intended for general information purposes only and does not take into account your personal situation, nor does it constitute legal, financial, tax or other professional advice. You should always consider whether the information is applicable to your particular circumstances and, where appropriate, seek professional or specialist advice or support.

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Recession-proofing your business

As a smaller business owner, you’ll know all about rising costs.

With tips on everything from energy efficiency to securing funding, our Guide to Building Business Resilience can help your business prepare for the future.