The term ‘profit’ in business is defined as the financial gain arising from the difference between the cost of doing the business and the earnings received from it. The term ‘Inflation’ in Economics, on the other hand, refers to an increase in the general price level where the purchasing value of money diminishes.
Hence, the financial gain from business doesn’t really hold good if the purchasing value of that sum of money falls. In other words, what the specific amount of profit will buy now, is much lesser than what it would have bought previously. Hence, ‘profit is not profit if inflation nullifies it’
How inflation affects business and its profit
In order to go in depth into this statement and understand what it means, let’s briefly look at how inflation affects business and its profit.
For companies, inflation results in rise of prices of raw materials, thereby increasing the cost of production. This in turn leads to change in the price of products. Constant changes and reprinting of prices on products leads to increased ‘menu costs’ for the companies as well.
Raising the product price on the other hand negatively affects product demand in the market since consumers become irritated and blame the company. Hence, companies refrain from increasing prices as much as possible. Increase in cost of production coupled with lack of price increase, squeezes the profit margins for a company.
The route towards bankruptcy in the future
This squeezing of profit margins sometimes lead companies to manufacture those products which in real terms sell for less than what they need to manufacture. But this however is clearly the route towards bankruptcy in the future.
Apart from the above issues, inflation also creates uncertainty and creates huge problems in production planning from the point of view of the companies.
For an individual, exploring best price options can be fun but for an organization that buys in bulk volumes, this might be a daunting task. Even minute change in prices, thus, results in mammoth implications.
Hence businesses prefer going for long term lock-in period contracts in order to minimize the risk of the buyer. This of course negatively affects suppliers and thus suppliers tend to refuse this for long term.
Inflation results in a vicious cycle
With rise in prices employees ask for higher wages since the same amount of wages now can purchase far less no of things. For companies whose cost of production has increased due to inflation, such employee demands are added pressure and further leads to the squeeze in the profit margin.
To conclude it can be said that inflation results in a vicious cycle. Production costs increase so companies charge higher prices. Consumers buy at higher prices hence ask their own employers for higher wages. Increased wages leads to further increase in cost of production and thereby price of products and hence the cycle goes on and on proving that ‘profit is not really profit if inflation nullifies it’