Working Capital

Inflation Is Up, Margins Are Down — How Early Payment Can Help Mitigate Margin Compression

October 12, 2021
The C2FO Team

Like the pandemic, inflation is universal, does not discriminate and must be addressed.

As much as businesses seek differentiation, all too common is the fight against inflation’s effects — especially in the COVID-19 era.

Prices rose 5.3% in August compared with a year ago, per the Consumer Price Index. That was only a slight, one-tenth of a percentage point, an improvement from July and similar to year-over-year numbers compiled by the US Bureau of Labor Statistics from May and June. 

While some analysts claim these rates are “transitory” and likely to reduce in the coming months, specific numbers show concerning jumps.  

Consider these increases over the last 12 months ending in August: 

Although it’s named the Consumer Price Index, business cost categories are also impacted. 

Margin compression, and how to mitigate its effects 

Your business or industry is likely experiencing margin compression, defined as the reduction in gross margin due to inflated costs. When revenue is flat and vendor or supplier costs are up, margins are down. It’s that simple. 

The income statement will tell you to grow sales faster than cost increases. Alternatively, reduce expenses wherever possible. You may, however, have limited control over either of these options.  

Where you may have more control of results is by offering accelerated payments to your suppliers in exchange for a discount. When using your cash on hand to receive a discount as an early payment incentive, you can improve your gross and net profits to offset inflationary costs and improve your business’s financial health.

Extending an early payment incentive can come down to knowing your obligations and opportunities that can be served by the cash; and your supplier’s cash conversion cycle (CCC), which measures in days the time needed for inventory investments to convert to cash. CCC will differ by industry — and consistent with other financial key performance indicators — the smaller the number, the better. During these inflationary times, your suppliers need a faster CCC to hold prices steady and keep supply chains stable. 

Win-Win: Early payments can benefit the customer, the supplier and the consumer 

With today’s minuscule returns from idle cash, capable companies can implement a strategy of paying suppliers early to offset higher prices or achieve greater returns on cash. Today’s reduced margins will continue when sellers incur higher costs from suppliers. 

However, you can mitigate margin compression through early payment of your suppliers' discounted invoices. You’ll earn more on your cash while reducing the effects of inflation and can resist raising prices for consumers. By actively and successfully managing your accounts payable, you'll protect your company’s bottom line.

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