How Inflation Affects Small Business Loan Approval

Inflation has turned the economy on its head for the last couple of years. It is nearly a race among advancing and succeeding entrepreneurs to score small business loans only to find stiff competition. The interest charges have also risen in tandem with inflation. To solve these issues, the lenders have raised their standards for granting loans.

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When making a small business loan, things are not as simple as they used to be. Thus, small companies and start-ups in the US have to pay attention to the cost of borrowing and inflation since it determines the loan approval cost for financial planning.

This article will dwell on the impacts of inflation on small business loans, ensuring you are well equipped to answer the question when the time comes to apply for a loan.

What You Need to Know About Inflation

Inflation can be described as the persistent rise in price level of goods and services in an economy and the devaluation of money. In other words, with a high rate of inflation, any given amount of money will be able to purchase smaller amounts of goods and services than it could previously.

For example, a small business owner needs to understand inflation because it affects his costs, prices, and the availability of resources for their operational purposes.

What Causes Inflation?

Inflation can be caused by three basic factors:

Demand-Pull Inflation: This phenomenon happens when the level of demand thwarts supply and distribution capabilities. High locusts, consumer spending, or a company's operational activities could be some of the factors driving such demand.

Cost-Push Inflation: This type comes into existence when firms try to pass abnormal costs of production by increasing the prices of their products. A few usual culprits are costs of labor going up, the price of input goods going up, or even hitches in the supply chain.

Built-In Inflation: This is also referred to as wage-price inflation. It comes about anytime businesses and their workers expect prices to rise in the near future. This makes the workers demand higher wages, and in turn, this compels businesses to raise their prices as a way of passing on workers' costs.

How is Inflation Measured?

Inflation is usually calculated in a mathematical manner by using averages that reflect the value of a certain basket of goods over a defined period of time. A few of the most frequently used include:

Consumer Price Index (CPI): This index is actually computed on the average prices for several consumer goods and services in a particular area, usually the urban consumers. It also happens to be among those commonly quoted indicators of inflation, as it has impacts on living standards.

Producer Price Index (PPI): This index records the average price of a given national output in a given period. It views prices from the perspective of the seller only.

Core Inflation: This index excludes some fluctuating items such as food and energy costs to describe trends over a longer period of time.

The Effects of Inflation on the Economy

Inflation can either harm or help an economy. Moderate inflation is believed to be a positive factor for growth since it encourages purchasing and investment.

On the other hand, high or volatile inflation has the opposite effect—it creates uncertainty and low confidence in consumption patterns and thus negatively impacts economic growth.

When small businesses make decisions regarding finance, the concept of inflation comes in. Costs may be affected by shrinking profit margins as they continue to rise, along with increased borrowing costs, often instigated by inflation.

How Inflation and Interest Rates Affect Small Business Loans

Interest charges and mortgage availability are important aspects of small business loans that are affected by inflation. In order to keep it under control, the Federal Reserve tends to increase interest rates. However, high interest rates make borrowing more expensive—be it for personal or business financing options.

The usual response of the lenders is to adjust their eligibility criteria, closely monitoring the financial health of the borrowers. This means small business owners have to bear higher loan costs, more stringent qualification requirements, and other stringent terms when they seek funding.