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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