“High turnover businesses can use loans as a hedge against inflation. Since the national currency value drops rapidly during such economic slowdown, when repaying such loans, what is being paid is actually a fraction of the amount borrowed in real terms-” Akin Monehin
A country experiences inflation when there is a continuous increase in the general price of goods and services.
National Bureau of Statistics reported a 22.95% food inflation rate (18.17% ‘general’ inflation) in March 2021. It also reported an unemployment rate of 33% and a negative economic growth rate. The trio is what economists refer to as stagflation (i.e., stagnant economy experiencing inflation).
Nigeria’s stagflation was triggered by the COVID-19 pandemic, which induced a global drop in the price of crude oil, Nigeria’s primary source of income. This negatively impacted government revenue. Productivity also nosedived, particularly during the lockdown. The Central Bank has been printing more money to support government expenditure. There has, however, been no corresponding increase in national productivity. More money in circulation with low productivity then resulted in a situation often referred to as “too much money chasing too few goods,” leading to a general price increase.
There are unintended consequences for businesses, of course. The cost of input (or raw materials) skyrockets. Domestic and foreign direct investments (FDI) decline. Customers have less disposable income, and those that are better-off are hoarding or converting their cash to more stable currencies, negatively impacting demand for domestic goods and services.
A sustained input price increase is not all bad news if the business can pass additional cost to customers. They are ultimately better off as they maintain the same margins on more expensive products.
Stacked Golden Coins With Increasing Blue Arrows On Reflective Background
Most businesses, however, are unable to do this. In such instances, it directly impacts the bottom line, significantly reducing their profits. Many go out of business.
Here are three (3) things businesses can do when prices of input increases:
Borrow cash: During inflation, lenders are worse off while borrowers enjoy the benefits. This is so because the real value of money (i.e., what it can buy) decreases with time. Suppose the inflation rate is rising year on year and likely to continue on that trajectory. In that case, businesses should borrow money at fixed rates (avoid variable rates). This is particularly sound advice for businesses with high cash turnover because that is a hedge against inflation. Existing loans should be renegotiated, spreading them over more extended periods. The value of a currency drops rapidly as the inflation rate rises. When repaying loans, therefore, you are paying a fraction of the amount borrowed in real terms. If the loan is used for productive activities, your venture is ahead of the prevailing economic situation.
Buy Stocks: While businesses requiring high cash turnover may borrow, businesses should not hold cash that is not actively engaged. Instead, they should lock in the present value of their cash by investing in stocks of companies producing “essential products.” Demand for essential products usually remains strong throughout the period of inflation, improving their business performance. Stocks of these companies would typically preserve value, providing a hedge against inflation. Companies that produce “essential” like salt, sugar, petrol, flour (& the derivatives like bread) usually can pass the increased cost of doing business to customers. Companies that produce addictive items like cigarettes usually also show strong performance through inflation. Real estate investments too. Monopolies also do well in an economy that is struggling with sustained price increases.
Sell Shovels: During the Gold Rush, it was those that provided shovels (and, of course, wheelbarrows, rugged clothing, logistics, accommodation, security, and other essential services) that became the millionaires. The majority of the miners did not become wealthy.
Is your business part of the frenzy, desperately searching for gold? Or is your business model objectively taking advantage of the economic situation?
Businesses should improve, pivot, or spin-off to ride it out.
A relatable example of ‘selling shovel’: By the time you are done reading this article, 2,500 new websites would have been created, with most of them ultimately not meeting the business objectives. That is a gold rush. A company like Google, on the other hand, provides shovels. Google made USD150 billion in 2020 on advertisement alone. It does not create content but provides a platform for websites to share their content. Cryptocurrency appears to be the new gold; has your business thought of investing in or spinning off a crypto wallet business? That is the shovel of today!
Your business should not struggle through the current unfavourable condition.