Two Things Leaders of Modern Finance Should Know This Week: (July 4th)

Two important announcements were made in mid-June of ‘22, and both may have a large impact on company prices, costs, and profits. Leaders of Modern Finance, including CFOs, are digesting the new information, and what the data means for their businesses. 

The first announcement was from the Federal Reserve.

Increasing the Federal Funds Rate

On June 15th, the Federal Reserve (Fed) increased the fed funds rate by a .75 percentage point, the largest increase since 1994. The fed funds rate is the interest rate that banks charge each other for overnight loans. Many other lending rates are determined based on the fed funds rate, including: 

• Adjustable-rate mortgage loans (ARMs)
• Credit card interest rates
• Auto loans
• Prime lending rate, the rate charged to a bank’s best (most creditworthy) customers

In addition, investors will earn higher rates on savings accounts and certificates of deposit. 

Why the Fed increased interest rates

The Fed took action to slow the rate of inflation by lowering demand for products and services. Increasing interest rates can slow down demand to the point that demand is no longer greater than supply, and prices decline.

Many financial analysts see an increasing risk that the US economy will move into a recession.

Defining a recession

The gross domestic product (GDP) measures the value of all goods and services produced in the US. When GDP declines for two consecutive quarters, the economy is in a recession. GDP increased in the 4th quarter of ‘21, and declined in the first quarter of ‘22. If GDP declines in the second quarter of ‘22, the US will be in a recession.

Interest rates and prices are closely connected, and the producer price index measures changes in prices.

Defining the Producer-Price Index

The US Bureau of Labor Statistics (BLS) calculates and reports changes in the producer-price index, a metric that measures what supplies are charging businesses and other customers. PPI is also referred to as the change in wholesale prices. Here is the May 2022 PPI data:

• The index rose a seasonally-adjusted .8% in May of 2022, and 10.8% for the 12 months ended in May ‘22.

• PPI measures price increases for both goods and services. Nearly two-thirds of the rise in the May index was due to prices for goods, with the remaining increase driven by the price of services.

• Energy prices, including gasoline were higher, along with the cost of transportation and warehouse services.

According to the Wall Street Journal: “May marked the sixth consecutive month of double-digit annual gains for producer prices.” Companies that purchase physical goods from suppliers- or ship physical products to customers- may be heavily impacted by the PPI increase.

A number of factors are driving the PPI increase.

Factors That Drive the PPI Increase

The Federal Reserve has kept interest rates low during the coronavirus pandemic, and consumer demand for goods and services has outpaced supply. In addition, the war in Ukraine has led to commodity price increases for wheat, precious metals, and oil. Finally, China’s periodic COVID-19 lockdowns have continued to impact supply chain issues.

Managers are operating in an environment with higher interest rates, increased wholesale prices, and supply chain disruptions.

Reducing the Impact of Higher Prices and Interest Rates

Well-managed businesses are proactive, and take steps to reduce the impact of increasing prices and higher interest rates. The strategies differ, depending on the company’s size, industry, and financial position. Consider whether or not these strategies apply to your business.

Passing on a price increase

The Wall Street Journal article discussed above explains that food suppliers and restaurants have been particularly hard hit by recent economic conditions. These firms are paying more for: “labor, packaging, ingredients and transportation. The rising cost of fuel is making it more expensive to produce and sell food.” 

Many food suppliers and restaurants are passing on price increases to customers. Consumers are seeing higher prices at the grocery store, and on restaurant menus. These changes are in response to higher prices and labor shortages.

Consumers may be willing to pay higher prices, if they value your product or service, and see your business as different from the competition. If buyers feel differently, a price increase will result in lower sales and a loss of market share.

Carrying less inventory

Retailers and wholesalers incur large costs for inventory, which reduces available cash for other purposes. If inventory prices are increasing, some managers will simply reduce inventory to control spending. 

Increasing competition and e-commerce offerings mean that your customers can buy the same product from a number of businesses. If you’re out of stock, or no longer carry a particular product, buyers may go elsewhere and not come back.

Managers must balance the cost savings of carrying less inventory with the potential for lost sales and disappointed customers.

Working more efficiently

Your best option may be to reduce operating costs to offset higher prices, and automation can help you lower business expenses. Think about the routine tasks that require staff time, and determine how much of each process can be automated. One common example is invoice processing and accounts payable.

Stampli’s end-to-end AP platform gives you full control and visibility over all your corporate spending, from cards to invoices to payments — all in one place. Stampli is #1 in Customer Satisfaction and AP Automation Leader on G2. Don’t just manage spend, control it with Stampli.