Business owners and investors are understandably concerned about skyrocketing inflation. Here are notable increases that occurred in 2022.
- The consumer price index (CPI) covers the prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. Over the last year, consumer prices have increased 8.3%, according to the latest data from the U.S. Bureau of Labor Statistics.
- The producer price index (PPI) gauges inflation before it hits consumers. PPI is up 11% over 2021, marking the second largest increase on record for wholesale inflation.
For your business, inflation may increase direct costs and lower customer demand for discretionary goods and services. This leads to lower profits—unless you’re able to pass cost increases on to customers. These are seven ways today’s rising inflation could affect your financial statements.
7 items impacted by inflation
1. Inventory
Under U.S. generally accepted accounting principles (GAAP), inventory is measured at the lower of 1) cost and 2) market value. Methods that companies use to determine inventory cost include average cost, first-in, first-out (FIFO), and last-in, first-out (LIFO). The method you choose affects profits and the company’s ending inventory valuation. There also might be trickle-down effects on a company’s tax obligations.
2. Goodwill
When estimating the fair value of acquired goodwill, companies that use GAAP are supposed to apply consistent valuation techniques from period to period. The assumptions underlying fair value estimates may need to be revised as inflation increases.
3. Investments
Inflation can lead to volatility in the public markets. Changes in the market values of a company’s investments can result in realized or unrealized gains or losses, which ultimately impact deferred tax assets and liabilities under GAAP. Concerns about inflation can also cause a company to revise its investment strategy, which may require new methods of accounting.
4. Foreign currency
Inflation can impact foreign exchange rates. As exchange rates fluctuate, companies that accept, hold and convert foreign currencies need to ensure they’re capturing the correct rate at the appropriate time.
5. Debts
If your company has variable-rate loans, interest costs may increase as the Federal Reserve raises interest rates to counter inflation. The federal funds rate is expected to increase over the course of 2022. You may want to consider converting variable-rate loans into fixed-rate loans, applying for additional credit to lock in rates before the next rate hike, or restructuring your debt. If you restructure your debt, it may be reported as a troubled debt restructuring, a modification, or an extinguishment of the debt under GAAP.
6. Overhead expenses
Long-term lease agreements may contain escalation clauses tied to CPI or other inflationary measures that will lead to increased lease payments. Likewise, vendors and professional service providers may increase their prices during times of inflation to preserve profits.
7. Going concern disclosures
Each reporting period, management must evaluate whether there’s substantial doubt about the company’s ability to continue as a going concern. Substantial doubt exists if it’s probable that the entity will be unable to meet obligations as they become due within 12 months of the financial statement issuance date. Soaring rates of inflation can be the downfall of companies that are unprepared to counter the effects, causing doubt about their long-term viability.
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Inflation can have far-reaching effects on your company’s financial statements. It’s important to spend time determining how to manage inflationary risks and reduce their negative impacts.
Have questions about how inflation is affecting your company’s financials?