Prior to the start of a project, it is smart for subcontractors to ensure that…
The pandemic accelerated economic trends and exposed weaknesses. Governments print money, while supply chains are disrupted. Locally, home prices are soaring. A global computer chip shortage could last up to two years. Inflation is becoming reality in our day-to-day lives. Yet, economists predict a period of strong economic activity in the years to come.
As communities reopen and economies rebuild, our post Coronavirus world will spit out winners and losers. How do we best position ourselves? Cash is king. Businesses should manage their cash more carefully than ever. Bubbles and inflation are upon us. Inflationary forces and economic bubbles can quickly tank a company’s bottom line, if businesses fail to pay close attention to the cost of material and services (both income and expenses). A working understanding of inflation and economic bubbles is invaluable.
Inflation: a continual rise in the price of good and services. (Merriam-Webster).
The Fed predicts higher sustained inflation than we have seen in several decades – currently 3.4% per year. Although the projected inflation is nowhere near the inflation crisis we experienced in the early 1980’s, businesses should update their business models and budgets to anticipate higher price increases than we have experienced in the recent past.
Bubble: a state of booming economic activity that often ends in a sudden collapse. (Merriam-Webster).
Bubbles exist when the market value rises rapidly to exceed the fundamental value. One of the first bubbles occurred in the 1630’s with tulips – known as tulipmania. The price for a tulip at its peak went six times the average citizen’s annual salary. The price of tulips would be worth fractions soon thereafter. Some investors grew very rich. More speculators grew very poor. Centuries later, history continues to repeat itself.
There are five main parts of a bubble described by economist, Hyman Minsky. First is displacement – when there is a new buzz or concept that is catching everyone’s attention. Second is the boom – after slowly rising prices, there is a lot of media attention and fear of missing out, so everyone buys.
This natural rise in prices is called demand-pull inflation. Third is euphoria – prices are at an all-time high and the belief that there will always be someone willing to pay higher. Fourth is profit-taking – individuals are selling to reap their profits and it is possibly reaching a burst point as more and more sell. Fifth is the panic – once the bubble has a slight puncture everyone is willing to sell at any price they can get and prices drop quickly, the bubble is now gone. (https://www.investopedia.com/articles/stocks/10/5-steps-of-a-bubble.asp).
Skyrocketing lumber prices have rocked the construction industry. It appears the lumber bubble has burst, as lumber futures have consistently fallen for more than a month. Given supply chain disruptions which continue to work through the worldwide economy, business owners should expect to encounter additional price bubbles in the months to come.
As businesses navigate these larger economic trends, strong cash management practices prove more important than ever. We suggest that all of our business clients consider these three tips:
- Take a close look at your business’ collections practices. Develop rigid, yet professional, collection practices to ensure that past due customers receive regular communications about past due balances. Make certain your business practices identify any applicable legal deadlines (e.g., lien or bond claims).
- Update the pricing structures of your client contracts to accommodate price fluctuations. Price escalation clauses are quickly becoming the norm in industry contracts.
- Focus on Client Development – While weak businesses will likely fail in the years ahead, winners will also emerge. Take a look at your existing and prospective client base for businesses that are well positioned to succeed in this emerging economy. Pay attention to those relationships, and both sides will likely profit from the return.
By: Chad J. Cochran