For the last few decades, small businesses in the UK have largely avoided the threat of inflation. Owners have enjoyed a period where interest rates remained relatively low and consistent. In fact, recent rises brought such disbelief that many commentators were adamant that the economic symptoms would be short-lived – that it was linked to the easing of post-pandemic pressure.

We now know this is not the case. UK inflation reached 9.4% in June, and is predicted to hit 13% before the year is out, showing the problem clearly extends beyond the pandemic.This has prompted central banks to raise interest rates. The Bank of England recently increased  rates by 0.5% to 1.75% – the biggest rise in 27 years – to combat the threat of spiralling prices.

While rate rises bring their own problems for managing debt, the impact of inflation on business owners is amplified in an environment of increasing costs and a cost of living crisis.

Here, we take a look at some of the core challenges facing you and your business, and most importantly, potential routes to mitigate them.

Facing up to the risks

It is likely that you are facing rising costs across many of your major expense categories such as the cost of the stock that you sell, energy bills, wages, fuel and rents. For some small firms, your own costs will be rising even faster than inflation. For example, those with reliance on transport are facing petrol price rises much larger than the aggregated inflation rate.

Meanwhile, you may be struggling with the issue of late payments from bigger firms. Xero Small Business Insights data shows that payments are being delayed on average by 8.5 days beyond the agreed terms, creating a significant cash flow problem for owners and operators.

In fact, data from Xero’s recent Cash Flow Crunch report highlights that nearly one in four small businesses experienced negative cash flow – when expenses in a given month exceed revenue – for at least six months in 2021, seriously impacting their growth plans.

This is despite 78% of large businesses acknowledging they are fully aware of the impact late payments can have on their small business suppliers.

At the same time cost of living pressures are rising, as inflation increases faster than wages. This means your customers are facing their own pressures. Real wages – nominal wages less inflation – are falling. This means consumers can no longer afford to spend in the same way as before.

Now, small businesses are facing a double hit from inflation – coping with rising costs while the spending power of their customer base falls.

Holding the course in stormy waters

As these pressures grow, it is vital that you maintain a close relationship with your trusted advisors to maintain profitability. Working with your accountants and bookkeepers, for example, can help you identify the right amount to raise prices and ensure a balance between profitability and customer retention. This is crucial to get right if businesses want to remain viable.

Despite this challenging environment, there were some green shoots to indicate that small businesses were proving resilient to these changes. Our Xero Small Business Index data showed sustained progress around sales across the UK, with 15 consecutive months of double digit sales growth until May 2022.

However, it appears that growth is now slowing, with sales only growing 5.2% year-on-year in June, a 3% real-terms decline compared to last year once price rises are factored in. A sign that the cost of living crisis is starting to have an impact on consumers' wallets.

Small businesses need support

As central banks battle to get inflation back under control, there is more the government can do to support the small business economy. Getting tougher on late payments, for example – either by creating incentives for large firms to pay suppliers on time, or imposing fines on those that don’t.

By working closely with trusted advisors, you can also identify areas where you can make savings to give yourself more room when it comes to pricing decisions. For example, by ordering supplies in a more timely way to avoid last minute costs, and diversifying the supply network you can be sure the costs you are being quoted are the most competitive.

While there is no single fix for these challenges, with the right support, you can ensure your small business is healthy, thriving and ready to take advantage of future opportunities.

Louise Southall is an Economist at Xero.