Is all of this economic talk confusing? Are you wondering where you stand in terms of this economy? Do you think about how any turn in the economy will impact your business and personal life? How about monetary policy? Fiscal policy? Tax policy?
Enough already! This topic is enough to drive you nuts!
Unfortunately, every CEO on the planet should spend some time thinking about the ramifications of type of economy we are living with. Is it…
Inflation we are dealing with?
How about deflation?
And let’s not forget Stagflation
I am sure you are familiar with the terms, and most of you may have experienced one or two of these conditions in your business life. But if there was a definite turn from one for to another are you prepared to take steps modify your business transactions that protects your shareholder value.
To be more specific let me define each type of economic cycle:
INFLATION - A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money……and/or
DEFLATION - A persistent decrease in the level of consumer prices or an increase in the purchasing power of money….and/or a decrease in expenditures when the supply of goods exceeds demand.
STAGFLATION - Sluggish economic growth coupled with a high rate of inflation and unemployment.
Now that clears it up for you, does it not?
When you get down to it, we are talking the old demand and supply theory from your Econ 101 class years ago. Add in what you learned in your money and banking class and you probably are close to understanding the different economic cycles.
So where are we currently?
Your guess is as good as mind, and I suspect it is strongly related to where your business in located and the type of customers you service.
Looking over the three definitions we can say that we are in a sluggish economy. Tough to argue with this suggestion.
Unemployment, on the other hand, may be good or it may not be good in terms of spending when 35-40% of the folks are not working.
In terms of prices, I would have to say, they, for the most part, are declining especially when you consider commodity prices and other assets that have yet to recover from the Great Recession. Productivity and the internet of things also add to price declines because productivity produces more goods and thus increases the supply side of the equation.
All things considered the cycle I would discuss at my planning meetings probably should be a deflationary cycle. I am not saying we will incur a severe deflationary cycle but want to consider what steps I would need to consider to plan for one should it occur.
So, what would you expect to happen if a deflation cycle rears its ugly head?
- Reduced business revenue
- Falling prices = lower revenues…..with a need to continue to lower prices to stay competitive.
- Wage reduction and layoffs
- Variable costs need to go to meet the bottom line expectation.
- Lower overall wages= reduced spending and more lower prices
- Change in spending habits
- At first there may be a spike in spending to take advantage of lower prices. After that consumers may just avoid purchases hoping for prices to fall further.
- Less capital investments
- With asset values falling customers will tend to hold cash and avoid capital expenditures
- Reduced credit
- Asset values declining. Cash flow decreasing. Who is going to loan you money for reasonable terms?
Needless to say, you can imagine what a deflationary cycle would do to your bank account, balance sheet, shareholder equity as well as your income statement and cash flow. And don’t even think about what your auditors would do with the value of your rental fleets.
Most C-level executives have not experienced a deflationary cycle, which makes going through one a very a high-risk adventure. Since we may be closer than you think to a deflationary period it would pay to talk through a financial plan to deal with falling prices and excess supply.
If you believe we will face one of the remaining two alternatives you can review those as well and be fully prepared.
Garry Bartecki is a CPA MBA with GB Financial Services LLC. E-mail firstname.lastname@example.org to contact Garry.