As companies and lenders evaluate performance risk and expectations for 2022, it is clear that emerging trends need to be considered throughout 2022. At this point, it is unrealistic to consider inflation transitory, or to believe there is a magic switch that will eliminate labor and supply chain issues.
Both the consumer price index (“CPI”) and producer price index (“PPI”) have continued to increase in October. The 12 month change in the CPI, as reported in October 2021, was 6.2%. This is the highest level reported since prior to 2001, and is higher than the one month peak in August of 2008 of 5.6%.
The October 2021 PPI is reported at 8.6%, which is more than double the previous 10 year high of 4.0% in October 2011.
Even if the CPI and PPI begin coming down in future months, this high inflationary level is unlikely to be reduced to the extent that costs return to the previous levels. It is unreasonable to expect a period of negative price changes to offset the price growth the economy has experienced in 2021. As a result, businesses and consumers need to expect higher prices to continue, and should not expect prices to return to historic levels. The percent increase may reduce, but expecting a negative CPI and PPI to counteract this inflationary period should not be part of the 2022 planning process.
The Fed uses the Personal Consumption Expenditure (“PCE”) Price Index to measure inflation, in part because this index is thought to provide less volatility. The most recent PCE is September 2021 and that was a high of 4.4%.
A business must consider inflation as a potential impact on costs, and revenues, in 2022.
The labor market is continuing to be problematic for businesses. The October unemployment rate was reported at 4.6%, and the labor participation rate was 61.6%. The unemployment rate is continuing to reduce from the peak Covid-19 shut down levels. However, the labor participation rate is not increasing back to the pre-Covid-19 levels.
Looking at state by state unemployment the data shows the lowest unemployment rate of 2.0% in Nebraska and the highest unemployment rate of 7.5% in Nevada and California. The next graphic shows unemployment rates by state.
The number of unemployed persons per job opening in September was 0.7. This is the lowest level since at least 2006.
The Institute for Supply Management (“ISM”) reported the October 2021 Manufacturing ISM at 60.8%, which is the seventeenth consecutive month of growth. While the rate of growth has slowed from 61.1% in September, the economic growth continues. The October 2021 Services ISM also reported the seventeenth consecutive month of growth at 66.7%. This is a 4.8% increase from the September 2021 Services ISM of 61.9%.
The October 2021 production materials lead time days was 96 days, a four day increase from the 92 days reported in September. This is the highest lead time in days since the data has been collected starting in 1987. The wait time for supplies used for maintenance, repairs and operations was at 45 days in both September and October, with 45 days being the highest reported level.
What does this mean?
These statistics show inflation, commodity price changes, labor issues, and supply chain disruptions are no longer emerging trends. These are trends businesses need to be prepared to effectively manage to ensure successful operating performance in 2022. The tools and techniques that we have addressed previously are a necessary part of the analysis and planning that a successful management team employs as they plan for 2022 and beyond.
Sensitivity analysis is key. How does a $1.00 per hour change in labor costs impact profitability? How does a 1% increase in nonpayroll expenses impact profitability?
Proforma planning of cost changes is key. Increasing benefits or other techniques to entice workers to come to or stay at a company must be modeled for performance impact. Increased shipping costs need to be modeled.
Price volume variance analysis must be employed for revenue items and for key input components.
Working capital impacts must be considered. Increased inventory levels, shorter supplier terms, longer customer terms, and other accounts receivable, inventory and accounts payable changes need to be evaluated for their impact on the operating cycle and on cash flow. The availability of liquidity to support these working capital changes must be modeled to ensure lines of credit are sufficient and the capital structure is appropriate in this new environment.
Weekly cash flow modeling is key to success moving into 2022. The cost dynamics coupled with working capital impacts requires detailed cash flow modeling. This modeling also helps identify problems quickly, as weekly budget to actual reporting will show changes before the income statement or balance sheet for the month end are reported.
2022 is going to be a challenging year. Planning and analysis are ways to reduce performance risk and identify areas for possible improvement or change before a company drops into unsustainable performance levels. Senior management of a company needs to be considering, evaluating, and planning for these trends to consider. It appears we now know what the New Normal will look like for 2022, and it will be challenging.