Restaurant owners have had a tough couple of years. The lockdown presented its own set of challenges, but now that shutdowns have ended in most locations, record-high inflation, labor shortages, and ongoing supply chain issues are leaving many restaurants struggling to find the best path forward. If you’re a restaurant owner looking for ways to understand and handle inflation better, you’ve come to the right place. This guide will cover inflation’s impact on restaurants and what steps you can take to mitigate its effects. During the past 6 months, 45.7% of U.S. restaurant owners have reported a noticeable increase in the price of goods and services. What Is Inflation and Why Is Inflation Bad? Inflation is an economic concept that describes a devaluation of currency and an increase in the price of goods and services within an economy over time. While most people view inflation through a negative lens, it can actually be a sign of a healthy economy. Economies have a natural cycle with ebbs and flows, and inflation is considered a part of this process. As an economy grows, members within it have more money and, as a result, spend more—growing the economy further. Demand for goods and services increase when an economy is thriving, and businesses will raise prices (inflation) if the demand outpaces their supply or output. This is known as demand-pull inflation, and it can be a signal of a growing economy. The Federal Reserve believes that a healthy rate of inflation ranges between 1.5% and 2% year-over-year. This steady, predictable inflation keeps an economy growing and money circulating. However, inflation becomes a negative signal if it happens too quickly or at a consistent rate above 2%, which is what we’ve experienced since the start of 2021. February 2022 was the highest 12-month inflation rate (7.9%) since 1982. This marks 13 consecutive months with an inflation rate of 2.6% or higher and an average of 5.725% over that time. Chart via US Inflation Calculator One of the major concerns with elevated, long-standing inflation is the stress it puts on businesses and consumers within an economy. The restaurant industry illustrates this point perfectly. A change in inflation from 2% to 8% turns a $4.00 gallon of milk to $4.32 (8%) instead of $4.08 (2%). A difference of $0.24 may not seem significant individually, but if you’re ordering dozens of gallons of milk every month it adds up. Not to mention, the inflation of other ingredients and produce further increases your cost of doing business. Restaurants: Who Is Impacted By Inflation the Most? There’s debate as to whether inflation is caused by a surplus of money (i.e., the Federal Reserve injecting money into the economy through stimulus bills during the pandemic) or an increase in the prices of consumer-facing goods or services (i.e., the price of beef has increased by 9.6% year-over-year causing restaurants to raise their burger prices). Regardless of its cause, inflation is felt by both individuals (consumers) and businesses. Within your restaurant, inflation affects your business, employees, and patrons differently. Restaurant patrons (negative): If you decide to offset inflation by raising prices, you’re simply passing on the inflation to your customers, which could lead to fewer customers. In 2018, Starbucks increased prices and saw sales transactions decline by 1%. Shake Shack also raised theirs and saw transactions decline by 4%. Commission-based restaurant staff (positive): Your staff who are paid through tips or other commission structures may see an increase in their pay due to higher prices—assuming the same sales volume. Salaried restaurant staff (negative): Your staff paid on salary will have a negative response to inflation because external costs like gas, food, and shelter are rising while their pay remains constant. Restaurants/owners (negative): Unless you make changes, inflation is most likely to hurt your restaurant because of increased input costs and lower profit margins. How Does Inflation Impact Restaurants? During the 12 months ending in January 2022, restaurants experienced the following increase in prices: Food: 7.9% Electricity: 9.0% Natural gas: 23.8% Other items: 12.3% Shipping: 11.14% Rents (shelter): 4.7% Computers: 1.03% Meat, fish, poultry, eggs: 13.0% Fruits and vegetables: 7.6% Non-alcoholic beverages and materials: 6.7% Truck transportation of freight: 18.3% Maintenance and repair: 18.1% Restaurants can often weather short-term cost spikes without making significant changes, but a 13-month inflationary period creates a catalyst for change. As a side note, during the 1970s and 80s, inflation remained above 4% per year for 9 years (1973-1982). Inflation has direct and indirect effects on your ability to run a successful restaurant—the most obvious being ingredients and food costs. The Consumer Pricing Index, which measures average price changes over time in several consumer industries, reports that the index for dairy and related products grew by 5.2% and fruits and vegetables by 7.6% from February 2021 to February 2022. The largest change was the meat, poultry, fish, and eggs index, which rose 13% from last year. These food categories play an important role in almost every restaurant, and odds are that you use many, if not all, of these foods in yours. As their prices increase, so do your costs—and it chips away at your profit margins. With restaurants already having razor-thin profit margins (3−5% on average), anything hurting your profitability can kill your growth. Let’s use the example of a cheeseburger to help illustrate inflation’s effect on restaurants. The $1 cost of a quarter pound of ground beef now becomes $1.13, the $0.50 in cheese is now $0.53, the $0.40 in tomato, lettuce, and onions are now $0.43, and the bun goes from $0.50 to $0.52. So, that cheeseburger that cost you $2.40 before now costs $2.61 or 8.75% more. If you sell 100 cheeseburgers a week, that’s $21 more in expenses. Across 52 weeks, that’s $1,092 more. Beyond the direct costs, inflation also affects supply chain partners, customer spending habits, the value of savings accounts, and adds pressure to increase employee wages because they need more money to cover their same expenses. The effect of inflation on supply chain partners is one of the more important considerations for your restaurant. Inflation is felt at all levels of the supply chain—including your vendors and distributors. When your supply chain partners are hit with inflation, they may raise their prices, renegotiate their terms, change delivery schedules, or even close their business, which will all have an effect on your restaurant’s operations. When inflation occurs over a longer period of time at a sustainable 1.5%−2%, it’s easier to handle through incremental changes. When inflation happens more quickly and steeply like what we’re currently experiencing, the pressures require more immediate action. Ways to Mitigate Inflation’s Effect On Your Restaurant As a restaurant owner, you make many decisions and control several operations within your business—but you can’t control inflation. Inflation is a natural process caused by hundreds of unique circumstances within an economy. While you can’t stop inflation from impacting your restaurant, you can mitigate its negative effect. Here are some ways to soften the impact of inflation on your restaurant. Refocus and Optimize Your Restaurant for Profitability If you weathered the storm of the lockdown, you can certainly get your restaurant through an inflationary period. A lot of restaurant owners used the early part of the pandemic to reevaluate their business and make critical changes such as integrating a delivery or take-out component. It’s time to do that again. Now’s the perfect time to take a deep dive into your restaurant and look for waste, opportunity, and strategic changes that can make significant improvements to your profitability. Consider some of the following questions. Can you modify your menu items to improve profitability? Maybe you have a really popular item that you can pair with a less-popular but higher-margin item to create a combo that you charge more for. Can you find better vendors and suppliers? Try looking into other partners that may have more competitive prices. It may at least give you an opportunity to renegotiate with your current vendors. Can you cut the fat? Are there wasted expenses in your restaurant? Maybe there are perishables that you often throw out or expensive menu items that aren’t as popular. Look for expenses that you can eliminate. Should you raise your prices? A recent study by CNBC found that 47% of business owners interviewed have raised their prices because of inflation. Raising your menu prices can offset inflation, but it could strain your relationship with patrons. Manage Inflation with Consistent Cash Flow Inflation, like any financial challenge within a business, favors those with more liquidity. Cash flow is one financial measurement of liquidity. Cash flow is the net amount of cash (liquid) money flowing through a company over a period of time. When it’s positive, that business is bringing in more cash than it is spending. When it’s negative, they are spending more than they have. Consistent cash flow in a restaurant means you have stability. It gives you the money needed to cover your supplies, ingredients, and other expenses so you can continue operating as usual. Equally important, consistent cash flow allows you to plan and budget for the future. If you know how much cash you’ll have available tomorrow, you can make better decisions today. Consistent cash flow affords restaurant owners assurance and gives them stability in an uncertain time. Unfortunately, the nature of the restaurant industry makes it hard for restaurant owners to maintain consistent cash flow on their own. You pay for the equipment, the ingredients, the chef, the waitstaff, and all the other overhead that goes into operating your restaurant regardless of whether customers are walking through your door. If your restaurant offers catering for events like weddings or other parties, you front most of the costs in time, money, and other resources—but typically receive payment after the event. Running a restaurant means you’re often facing negative cash flow scenarios, because the restaurant spends money before it receives payments. So, even if your restaurant is busy and successful, there may be times when you don’t have the working capital (cash flow) you need to cover some immediate expenses. Even restaurants that typically operate cash flow positive can struggle for stretches when financial issues like inflation put additional stress on their business. To help in these situations and to even out your restaurant’s cash flow issues, you may want to turn to small business borrowing solutions like a business line of credit and merchant cash advance. A business line of credit may be the perfect solution for your restaurant. It serves as a financial safety net—accessible anytime you need it, but without obligation to use it. A restaurant line of credit only charges you for the money borrowed and not the full amount. Once you repay what you’ve borrowed, your credit limit returns to the qualified amount—which can be as much as $500,000. So, if you need cash to purchase ingredients for an upcoming catering event or extra money to repair a damaged grill, you can pull from your line of credit and continue operating as usual. Even though you may add on more debt with a restaurant business loan, something like a line of credit can often provide the cash flow predictability you need to weather a difficult financial period. As an added benefit, both lines of credit and merchant cash advances fund quickly, which means approved borrowers won’t need to wait months before they can access their cash. You Have the Ingredients for Success Restaurant owners have a lot on their plate (excuse the pun). Adding high inflation to the recipe makes the job even more challenging. But there are solutions that help you keep your cash flow consistent and prepare for almost anything. Interested in financing? Find out what your small business is eligible for with Lendio’s 15-minute, online application. Data sources: https://www.ers.usda.gov/data-products/food-price-outlook/summary-findings/ https://fred.stlouisfed.org/categories/33583 https://www.bls.gov/ppi/ https://www.nbcdfw.com/news/local/construction-costs-hit-highest-spike-in-50-years/2891677/ https://www.agc.org/sites/default/files/users/user21902/PPI%20Tables%202022_01.pdf https://www.cnbc.com/2022/03/10/rising-airfares-are-giving-people-spring-break-sticker-shock.html https://www.macrotrends.net/countries/USA/united-states/inflation-rate-cpi Disclaimer: The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.