What Is Inflation? A Guide for Small Business Owners in Canada

Canadian small business owners are always faced with budgeting decisions addressing inventory, payroll, and profitability. But when prices start rising because of inflation, how can they manage them and maintain a profit?

Inflation can quietly erode profits, change customer behaviour, and disrupt a business’s financial plans.

Canada’s Consumer Price Index (CPI) – the measure of the average price of goods and services and an economic indicator for inflation – rose by 1.7% in July, a slight decrease from 1.9% increase on a year-over-year basis in June, according to Statistics Canada.

That’s still less than the 2.7% inflation rate we had in January, and it’s below the Bank of Canada’s (BoC) preferred 2% rate of inflation.

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However, the 2025 Zensurance Small Business Confidence Index survey found nearly half (48%) of Canadian small business owners cited inflation as the most significant issue they face this year – an 18% decline from one year ago when 58.6% of business owners told us inflation was their top concern.

Meanwhile, a majority (54.3%) of business owners pointed to increasing their prices as their most pressing concern this year, possibly reflecting the impact inflation is having on them.

This guide provides an overview of what inflation is, how it impacts interest rates, and makes recommendations for Canadian small businesses to try to manage its effects.

What Is Inflation?

Some may think inflation means “everything gets more expensive.” But that’s not the whole story.

Inflation is the slow and steady rise in the price of goods and services over a period of time, and reduces the purchasing power of money. That means as inflation increases, a dollar buys fewer goods than it did previously.

However, inflation is a regular part of the economy. For instance, if consumers know inflation is rising and prices are increasing, they may buy the goods and services they want now rather than wait until later.

It’s only when inflation is persistently high or unpredictable that it can unsettle consumer and business confidence and erode economic stability more broadly.

What Causes Inflation to Rise?

Inflation primarily stems from an imbalance between demand and supply. It occurs when the demand for goods and services outstrips supply, and leads to price increases and rising inflation.

Many factors cause inflation to increase, such as:

• Government spending: When the government pumps a lot of money into the economy, like with stimulus cheques, there’s suddenly a lot more cash floating around competing for the same quantity of goods. That can drive prices up.

• Shocks to supply chains: Shocks that disrupt or hamper supply chains lead to shortages in raw materials and finished goods, in turn, increasing costs. For instance, during the COVID-19 pandemic and its subsequent government-ordered lockdowns to contain the disease, supply chains ground to a halt.

• A country’s monetary policy or interest rate: The Bank of Canada (BoC) is our country’s central bank. Its primary function is to keep inflation low by setting the country’s benchmark interest rate (the BoC’s preferred rate of inflation is at or near 2%). As of August, the BoC’s benchmark interest rate was 2.75%.

Other contributing factors to the price of goods include their scarcity, the cost of labour and raw materials needed to produce them, and the level of competition among sellers offering those goods.

How Does Inflation Affect Interest Rates?

Inflation has a direct impact on Canada’s interest rates, which the BoC sets.

When inflation is high, the BoC typically raises the interest rate. When inflation dips below the BoC’s target rate of 2%, it may lower the interest rate or maintain it at its current level, as it did in its last rate decision on July 30. The BoC’s next interest rate announcement is scheduled for September 17.

The goal behind raising interest rates is to cool down consumer spending and reduce demand, increase the cost to borrow money, and encourage people to save since higher interest rates can yield better returns on savings and investments.

When inflation is too low or the broader economy appears to be in a slump, the BoC might lower the interest rate. A lower interest rate can stimulate consumer spending, make it cheaper to borrow money as loans become less expensive, and boost economic growth and activity.

How Does Inflation Impact Canadian Small Businesses?

Higher inflation can make running a small business in Canada more expensive. It affects small businesses in several ways, including:

• It increases energy costs, like the price of gasoline and utility bills.

• It raises the price of raw materials and goods for the products businesses sell or produce.

• It causes the cost to borrow money to rise and makes it more expensive to pay off debts.

• It may impact the cost of a business’s payroll if employees expect their wages to keep up with rising living costs.

• It reduces consumer spending as customers look for cheaper products or services, and can affect a small business’s profitability.

• It makes managing daily expenses more difficult as higher prices affect inventory and a business’s operational overhead, leading to a strain on cash flows.

• For business owners leasing commercial properties annually that are up for renewal, a landlord may increase the annual rent to offset the effect of inflation on their books.

What Can Business Owners Do to Deal With Inflation Effectively?

There are a few steps business owners can take to try to manage the effects of higher inflation:

• Conduct an audit of your costs: When economic headwinds become a fiscal drag on your finances, drill down into your business’s monthly expenses to see if there are areas where you can reduce them. For instance, are there efficiencies you can achieve by eliminating ‘wasteful’ activities in your company through the principle of lean management?

• Audit the prices you charge customers: Raising the prices they charge their customers for goods and services is the most significant concern for 54.3% of Canadian small business owners. Although increasing the prices they charge can be tricky for business owners since their customers may not take kindly to them, modest price increases can potentially lead to improved profit margins.
  
  It might be worthwhile to consider small, gradual price increases over time versus a single large price increase on items or services. Communicate to your customers about the changes to your prices, why they’re necessary, and keep the focus on the value your business provides.

• Make budget adjustments: It may be necessary to revise and update your business’s budget forecasts to account for increased costs for inventory, raw materials, operational overhead, and payroll expenses.

Is Your Small Business Protected?

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We understand how important it is to protect your business’s finances and your livelihood when something goes unexpectedly wrong.

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– Reviewed by Brandon Bowie, Senior Broker and Team Lead, Professional Lines, Zensurance.