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What are the Effects of Inflation for Companies?

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Cost of Capital
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Ramon
Consultant, Spain

What are the Effects of Inflation for Companies?

What is the impact of increasing inflation on companies? I've already found 4 categories:

I. Effect on Liabilities

Higher inflation has POSITIVE effects in the liabilities side of the balance sheet, as it diminishes the present value of monetary liabilities such as long term loans.

II. Effect on Assets

But this advantage usually does not fully compensate the NEGATIVE effects that higher inflation has in the assets side, such as the loss of value of cash and receivables, and deviation of calculated depreciation among others.

III. Effect on Earnings

To counterweight the effects of increasing inflation, companies should not only PASS ON the full cost of inflation to the customers, but also have to INCREASE EARNINGS at a rate higher than the inflation percentage in order to fully compensate for the lower depreciation. Depreciation during inflationary periods is lower than the cost of replacement of depreciable assets and offers less tax shelter. To maintain the generation of cash flow, it is necessary to achieve rates of earnings growth above inflation. This can sometimes be a daunting task.

IV. Effect on Share Price

Also, during inflationary periods, the HIGHER COST OF CAPITAL in real and nominal terms reduces the present value of expected future cash flows and the calculated value of share prices. Financial markets liquidity, which might be present during inflationary periods, might not be enough to increase demand of shares and avoid poor stock market performance unless liquidity is also accompanied with a substantial appetite of investors for risk.
⇨ What am I still missing? Please explain it briefly.
 

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Anonymous
 

Impact of Inflation on Companies

I agree inflation impacts many aspects of finance and areas of business. The size of the impact that... Sign up

 
5
Norman Dragt
Netherlands
 

More Effects of Inflation on Companies

High inflation also influences businesses in many other areas beyond the financial one. Here are som... Sign up

 
1
Sarkis Yaralian
Director, Kuwait
 

Impact of Inflation on Cost of Product and Cost of Labor

During times of inflation, COST OF SALES (derived from cost of material and production overhead) wil... Sign up

 

More on Cost of Capital:
Summary
Discussion Topics
👀What are the Effects of Inflation for Companies?
topic Analysis of Capital Investments
topic Cost of retained earnings
topic Cost of Capital ( Equity Only)
🔥 What is the Difference Between Cost of Capital and Weighted Average Cost of Capital?
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More on Cost of Capital:
Summary
Discussion Topics
👀What are the Effects of Inflation for Companies?
topic Analysis of Capital Investments
topic Cost of retained earnings
topic Cost of Capital ( Equity Only)
🔥 What is the Difference Between Cost of Capital and Weighted Average Cost of Capital?
Special Interest Group

SIG Leader

Do you know a lot about Cost of Capital? Become our SIG Leader

Knowledge Center

Cost of Capital
Knowledge Center



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