The Impact of Inflation On Your Company’s Value

The Impact of Inflation On Your Company’s Value
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The past few years have been mostly unpredictable for business owners. However, almost all economic indicators currently suggest the beginning of a sustained inflationary period. In May, the U.S. Consumer Price Index (CPI) showed five percent inflation as measured by the Index change from one year ago. 

This long-term trend creates significant cost implications for businesses. 

While inflation is mostly inevitable, there are steps business owners preparing to sell can take to minimize the impact.

Rising Inflation Means Less Profit for Business Owners 

As inflation rises, the price of goods and services also increases. For business owners, the result is margin compression, meaning costs rise faster than the amount received from the sales of products sold, which leads to decreasing margins over time. 

Companies are less profitable on the same revenue and as a result, their Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) will also be less. 

What This Means When Selling a Business

EBITDA is the basis on which a company is typically valued. As a company’s EBITDA decreases, so does the company’s overall value.

The past year has been rough for many businesses—dealing with turnover, navigating disruptions in the supply chain, retooling operations post-COVID. Business owners who now know they’ll need to bring in more revenue to combat rising inflation have been dealt another major hit by this uncontrollable economic factor.

For those looking to sell in the next five years, this is especially unwelcome news. 

Here’s something else to consider. The typical lookback period when valuing or acquiring a business is three years. Say a business has one good year and two years impacted by rising inflation. When the owner goes to sell their business, those two not-so-good years will draw scrutiny. 

With fewer profits coming in, business owners can expect to receive less for the sale of their businesses as buyers are getting less from the sale.

Advice for Business Owners

If you’ve been patiently waiting for the right time to sell, that moment may be now. As time passes, higher inflation will continue chipping away at your company’s EBITDA. If you’re unable to pass this along to your customers, your company’s value will also erode. 

With the lookback period being three years and the impact of inflation and the resulting margin compression still in its early stages, accelerating plans to sell your business will likely result in a higher valuation today than in a few years from now when inflation has negatively impacted margins over the long term.

It’s Good to Have Options 

Schedule a discovery call with REAG to better understand the current value of your business and your options for a potential exit. During this call, we’ll get to know your business and share candid advice based on current market conditions. 

You must ultimately choose the best strategy to move forward. But we’re here to help.