Inflation has its biggest impact on the reported profits of businesses with sizable inventories. Consider the following example:
The increased profits of Patrick's PC Shop in the example above cannot be attributed to improved performance. They are merely "inflation profits."
Inflation also distorts reported income when the costs of fixed assets are charged to income through depreciation. The increased costs of replacing fixed assets are not reflected in the depreciation charge.
Inflation has an impact on how a business is valued by investors and
prospective purchasers, who do not value inflation profits highly. A business
that fails to take this factor into account in its financial planning may see
the value of the business decline, despite steady or modestly rising profits.