The Impact of Inflation: Inventory and Capital Planning

Understanding inflation is vital to managing your financial and material resources.  Inflation directly impacts financial decision making and cash flows because interest rates are directly affected by inflation.  Inflation is the rate at which the general level of prices for goods and services is rising. The first phase of inflation is expansion, that’s when growth is positive, a 2 percent inflation is considered healthy. Year-over-year inflation, is currently forecast to be 2.0 in 2018 and 2019.

Inflation creates uncertainties because of the rising prices in raw materials. As these prices rise, companies try and get ahead by accelerating their purchasing. Inflation is a key factor in the business cycle as inventory is built up.  Most firms would like the inventory/sales ratio to be kept low, minimizing the cost of storage and the cost of capital tied up in said inventory. While the recent ISM report for the manufacturing sector looked great last month, it is worth noting that not all the numbers were good.  While customer inventories showed a decline, so did the month over month numbers in production and new orders. With inflation in the air, those numbers have many on edge.

Inflation also has the potential to compound the impact on investing.  You many have a good backlog of orders however, you may be faced with the decision to invest in the costs related to replacing or updating under-utilized or outdated equipment. There is also the possibility of obtaining additional capacity. This balance is of special concern to those in the materials industries such as metals, plastics and paper, to name a few. This phase of the business cycle typically includes credit expansion.  Low interest rates are a false signal of readily available capital. Huge U.S. capital needs combined with an American economy that must modernize and expand in order to compete in an increasingly competitive world economy puts pressure on resource prices. When capacity is strained, new capital projects are often planned. Tread lightly, businesses can fail as a result of a boom, when the expansion slows down the debt can become unserviceable. The Federal Reserve said that inflation was likely to pick up this year, setting expectations that U.S. interest rates will continue to rise. Inflation and interest rates on capital loans are always entangled.

In recent days the uncertainty has grown, planning is always difficult however, with the Trump Administration’s announcement regarding new tariffs, an announcement that lacked details, has left many wondering.  John Hayes, Chief Executive of the Ball Corp., producer of beverage cans and metal food packages, told the Wall Street Journal “It’s the uncertainty that has many people concerned,…We don’t know what products it’s on. We don’t know from which countries it’s on. We don’t know how it’s going to be implemented.”  The Administration is expected to release details this week, however stocks of manufacturers that use metals plunged on the tariff plan news. As a result of the announcement and declining stock prices many banks warned against investing in the manufacturing sector.

For now, raw material prices have been rising to meet growing demand and there is a strong global economy, this should offset the impact of rising costs.



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