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The Consequences of Inflation for Credit Management

How are companies affected by inflation and what consequences does it have for their liquidity? Which effects will there be in the medium term?
Schumann Insights, Blog post, Videos
03.06.2022, Prof. Dr. Matthias Schumann

Current Situation in Germany and the EU

In Germany and the EU there are currently reports of an inflation rate of more than 7 %. In Great Britain even 9 % has been reported. The causes are

  • extreme energy price increases caused by the Ukraine war
  • increased rents due to a shortage of accommodation
  • rising building costs and product shortages triggered by the supply chain breakdowns and production stoppages resulting from the Chinese corona lockdowns in particular regions and also Chinese internal demand, which have caused availability limitations.

Equally, salaries and wages are increasing, although not to the same extent. Because of the continuing very low interest rates, savings are losing their value. The same goes for debts. Now, however, interest rates are starting to rise.

The Consequences for Companies

If we look at the effects on companies, the following can be observed:

  • Increasing prices for inputs, materials and labour raise the costs of production or the provision of services. If it is not possible to pass these costs on to the customers, the profit margin is reduced. This can even lead to losses.
  • Non-supply of inputs due to material shortages, for example, leads directly to a reduction in turnover. The question here is whether additional costs also arise, e.g. for the personnel, who now have less work.
  • In total, demand will be reduced because some consumers can no longer afford the more expensive products.
  • Equally, in B2B business many investments will be questioned. This will also lead to suppression of demand.
  • In the building industry, some authorized projects are already being cancelled because the building costs have risen faster than they can be passed on to the potential tenants. In addition, ecological requirements have also increased building costs.
  • The central banks are trying to control inflation by limiting the money supply and, in combination with this, increasing interest rates.

The consequences for companies are, on the one hand, massive cost increases, and on the other hand a reduction in turnover.

How Can Companies React?

The question that needs to be asked by credit managers is whether companies are in a position to reduce capacities quickly so as not to incur losses.

Additionally, the size of existing liquidity buffers can be checked to see whether the expected dip can be survived. Here, relevant predictions can be made using data from annual reports or even inter-yearly financial reports.

It is equally important to check the situation regarding borrowed capital. How long-term is the availability of the borrowed capital and how strongly will the company be burdened when increasing interest rates cause a higher cost of capital in the near future?

Overall, consideration of the whole industry can help to determine priorities in such investigations.

Which Industries Will Be Affected?

Energy-intensive companies are especially likely to suffer. With some delay, the building industry will also be affected. For trading companies with low margins, reductions in turnover could lead to financial difficulties. Companies with a high percentage of borrowed capital should also be focused on. These considerations should also be applied equally in the case of suppliers.

Automotive companies are currently experiencing an economic boom – very high profits have been reported. Here, however, it should be considered that there is state subvention available for E-mobility, short-time working allowance is still being paid and higher prices can be demanded due to low product availability. Also here, changes can be expected in the longer term.

In summary then, a differentiated view must be taken in order to control credit lines effectively in these times. Well-maintained data and tools that support analysis are very helpful in this situation. With this in mind, I wish you good decisions.