Inflation affects anything related to money, which means that the income statement, balance sheet, cash flow statement and a lot of other things in a given company are affected by inflation. As prices go up due to inflation, costs go up and so does revenue. However, high inflation negatively impacts the overall economy and can be reflected in high costs and declining revenue.
Inflation causes prices to rise. As the prices of some goods and services rise, the extra cost is often passed on to buyers in the form of higher prices for related goods. For example, if the price of oil goes up, the cost of shipping and transportation goes up and some or all of this increase is reflected in higher prices for goods that require shipping. As all of these individual prices rise, the overall price level of an economy rises. When the price level rises, most prices -- wages, real estate, groceries, machinery, etc -- tend to increase at a similar rate.
Roll of Inflation
Some inflation is normal and actually healthy for an economy. As an economy grows and generates more money, consumers and businesses have more money to spend. As buyers have more and more money available, sellers can charge higher prices, which leads to inflation.
Inflation and the Balance Sheet
Balance sheet values change constantly as a business acquires both new assets and new responsibilities. Inflation also causes balance sheet values to change, as rising inflation results in rising valuations for tangible assets. The value of cash and cash equivalents stays the same, but the purchasing power -- how much that cash can buy -- diminishes with inflation. In the “Liabilities” section, inflation tends to push wages and the cost of supplies and inventory up, inflating accrued expenses. Other liabilities may or may not change in value; debts with floating interest rates usually increase with inflation while debts with fixed rates stay the same.
Effects of Inflation
Inflation impacts businesses and individuals in myriad ways and is reflected in pricing structures, forecasts, invoices and many other areas -- not just the balance sheet. If inflation operates on a low level as a result of a healthy and growing economy, it impacts businesses in small ways and helps push steady growth in the values on financial statements. If inflation reaches high levels or gets out of control, it results in rising costs and often declining revenue on the income statement as it stresses the economy and economic actors.
- Tutor2U: Consequences of Inflation
- Tutor2U: Costs and Effects of Inflation
- Ludwig von Mises Institute; What Has the Government Done to Our Money? The Economic Effects of Inflation; Murray Rothbard
- National Center for Policy Analysis; The Fed' Balance Sheet and Inflation; Bob McTeer; July 2009
- The Federal Reserve Bank of Boston; The Impact of Inflation; Rebecca Hellerstein; 1997