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How can you account for inflation when forecasting a budget?

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Inflation is the general increase in the prices of goods and services over time, which reduces the purchasing power of money. When you forecast a budget, you need to consider how inflation will affect your revenues, expenses, and cash flows. Otherwise, you may end up with inaccurate projections, unrealistic goals, and poor financial decisions. In this article, you will learn how to account for inflation when forecasting a budget using some simple methods and tools.

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Asha Kanta Sharma

Manager - Finance & Accounts @ Opendoors Fintech | Financial Accounting

1 Know your inflation rate

The first step to account for inflation is to know the inflation rate that applies to your business. The inflation rate is the percentage change in the average price level of a basket of goods and services over a period of time. You can use different sources to find the inflation rate, such as official statistics, market indicators, or industry reports. Depending on your business, you may need to use a specific inflation rate for your sector, region, or product category, or a general inflation rate for the economy as a whole.

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Asha Kanta Sharma

Manager - Finance & Accounts @ Opendoors Fintech | Financial Accounting
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Inflation accounting is crucial in budget forecasting to accurately reflect the impact of rising prices on expenses and revenues. Key inputs susceptible to inflation include salaries, utilities, raw materials, and rent. Research inflation rates, apply historical data, adjust historical costs, use the Consumer Price Index, forecast inflation rates, adjust budget projections, differentiate between variable and fixed costs, evaluate contracts and agreements, perform scenario analysis, consider inflation-indexed investments, regularly update forecasts, communicate assumptions, use present value calculations, and seek professional advice for improved accuracy. This approach helps organizations adapt to inflationary pressures

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2 Adjust your nominal values

The next step is to adjust your nominal values for inflation. Nominal values are the values of your revenues, expenses, and cash flows in current dollars, without taking into account the changes in the price level. To adjust your nominal values for inflation, you need to use a formula that converts them into real values. Real values are the values of your revenues, expenses, and cash flows in constant dollars, which reflect the changes in the price level. The formula is: Real value = Nominal value / (1 + inflation rate) For example, if your nominal revenue for next year is $100,000 and the inflation rate is 2%, your real revenue is: Real revenue = $100,000 / (1 + 0.02) = $98,039.22 This means that your revenue in constant dollars is lower than your revenue in current dollars, because of the loss of purchasing power due to inflation.

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3 Use an inflation factor

Another way to account for inflation is to use an inflation factor. An inflation factor is a multiplier that you apply to your nominal values to adjust them for inflation. The inflation factor is calculated by adding one to the inflation rate and raising it to the power of the number of years. The formula is: Inflation factor = (1 + inflation rate) ^ number of years For example, if the inflation rate is 2% and you want to adjust your nominal values for five years, the inflation factor is: Inflation factor = (1 + 0.02) ^ 5 = 1.1041 This means that your nominal values will increase by 10.41% over five years due to inflation. To adjust your nominal values for inflation, you need to multiply them by the inflation factor. For example, if your nominal revenue for next year is $100,000, your nominal revenue for five years later is: Nominal revenue for five years later = $100,000 x 1.1041 = $110,410 This means that your revenue in current dollars will increase by 10.41% over five years due to inflation.

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4 Use a spreadsheet tool

A convenient way to account for inflation is to use a spreadsheet tool, such as Excel, Google Sheets, or Numbers. These tools can help you perform calculations, create formulas, and visualize the data. For example, you can create a table with your nominal values and the inflation rate for each year, apply the formula or the inflation factor to adjust your nominal values for inflation, compare your real values and your nominal values, and create charts and graphs to show the impact of inflation on your budget. The use of a spreadsheet tool can save time, reduce errors, and improve presentation. Accounting for inflation is an essential skill for forecasting a budget. By utilizing these methods and tools, you can avoid the pitfalls of inflation and make more realistic and informed financial plans.

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5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you account for inflation when forecasting a budget?

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1 Know your inflation rate

2 Adjust your nominal values

3 Use an inflation factor

4 Use a spreadsheet tool

5 Here’s what else to consider

Accounting

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