The year 2025 closes in an environment marked by inflation , observed or anticipated by economic players, well above historical levels. After nearly thirty years during which European inflation hovered around 2%, companies are now faced with a range of between 2% and 8%, depending on the country of activity, with variations that are often rapid and difficult to anticipate.
For a firm like XVAL, which specializes in the valuation of unlisted companies and assets, this new reality means that the models inherited from the low-inflation era need to be overhauled.
Inflation doesn't just affect prices: it alters flows, the cost of capital, balance sheet structure, employee, customer and supplier behavior - and therefore the intrinsic value of companies. Academic studies and the analyses of corporate finance experts all show that the impact of inflation on value is generally much greater than its impact on earnings, due to accounting and financial mechanisms that amplify the effects.
1. Mechanical impact: automatic flow reduction
The first observed phenomenon is mechanical: inflation reduces free cash flow, even when the company manages to pass on cost increases to its sales prices.
According to expert analysis :
- The increase in WCR is systematic. Working capital often grows faster than EBIT, as inflation simultaneously increases inventories, accounts receivable and accounts payable - but not in the same proportions. Inflation of 10% can generate an increase in WCR equivalent to several points of sales, immediately reducing available cash.
- Book depreciation is becoming insufficient. Allocations are calculated on the basis of the historical value of assets, while their future renewal must be financed at current cost, which is itself more expensive. As a result, a company can post apparently stable earnings while its operating cash flow deteriorates.
This discrepancy is critical for the appraiser: it skews the published accounts, distorts profitability ratios and makes certain projections misleading if realistic economic depreciation is not reinstated.
2. The effect on value: a disproportionate drop
Inflation reduces value through a dual effect:
- Contraction of future cash flows,
- Higher cost of capital (WACC).
When inflation rises by several points and long-term interest rates tighten, the nominal WACC mechanically becomes higher. Models show that inflation of around 8-10% can lead to a drop in value of over 25-30%, even if accounting results remain relatively stable.
To regain previous value, a company would often have to grow well above inflation, which is rarely realistic. This is exactly what academic analysis shows: value reacts much more strongly than earnings.
3. Inflation is profoundly changing economic behavior
Research in behavioral finance and industrial economics shows that inflation creates friction:
- Employees: wage increases do not keep pace with inflation, creating tensions, pressure on productivity and a more volatile social climate.
- Suppliers: renegotiations accelerate. Without indexation clauses, suppliers can suspend or delay deliveries.
- Consumers: they arbitrate more quickly. For example, during previous inflationary episodes, food inflation of 12% was accompanied by a drop in volumes consumed, indicating an immediate adjustment in behavior.
These phenomena increase uncertainty, reduce strategic visibility and make business plans more volatile - which has a direct impact on valuations.
4. Real interest rates: temporary but volatile support
In recent years, companies have benefited from negative real interest rates, i.e. nominal rates below inflation. But this situation masks two major risks:
- Underestimation of the real cost of debt: companies may have considered their financing to be less costly than it really was.
- Volatile access to credit: even with negative real interest rates, certain categories of debt (notably high yield) have become more difficult to refinance, or even temporarily inaccessible.
This directly affects projects, investment capacity and therefore value.
5. Structural factors make inflation sustainable
According to the analyses of economists and international financial institutions, several factors have a lasting impact on inflation:
- Energy transition: higher production costs, mandatory investment, carbon tax.
- Skills shortage: many technical professions are short of manpower, putting upward pressure on wages.
- Industrial relocation: closer but more costly value chains.
- Regulations: increasing number of obligations (ESG, reporting, compliance), driving up fixed costs.
In other words, current inflation is no accident: it reflects a profound transformation of the economy.
6. Example XVAL: a pedagogical case of value distortion
To illustrate these mechanisms, here's a pedagogical case used by XVAL (completely reinvented, but in line with the documented economic mechanisms).
A company makes :
- 10 M€ sales,
- 1.5 M€ EBITDA,
- WCR representing 25% of sales,
- and maintenance investments of 600 k€.
Let's assume inflation of 8%, fully passed on to prices.
Year N+1 - Actual economic impact :
- Sales rose mechanically to €10.8 million,
- EBITDA rose to €1.62 million,
- But WCR automatically increases by 200 k€ (8% × 2.5 M€),
- And sustaining capital expenditure rises to €648k.
Impact on flows :
- Initial cash flow: €1.5 M - €0.6 M - 0 = €0.9 M
- Cash flow after inflation: €1.62 M - €0.648 M - €0.2 M = €0.772 M
This represents a decline of -14%, despite a nominal increase in activity.
And if the nominal WACC rises from 10% to 12.5% due to the pressure on interest rates, the present value is reduced even further.
This example perfectly illustrates why nominal growth is not enough to preserve value.
7. What this means for value-adding in 2025
For professional appraisers, three consequences must now be systematically integrated:
A. Recalibrate cash flows in line with future prices
→ integrate economic depreciation, real capex and foreseeable increase in WCR.
B. Updating flows with a consistent WACC in a nominal world
→ long rates, sector risk premiums, credit structure.
C. Integrating volatility and inflationary frictions
→ alternative scenarios, stressed WCR, variable margins, social and supplier effects.
These adjustments profoundly transform the calculated value.
2026, the year when value enhancement enters a new era
Inflation acts as a risk multiplier: it reduces flows, raises the cost of capital, weakens economic relations and increases forecast uncertainty.
For a reliable valuation, it is essential to integrate :
- actual and expected inflation,
- mechanical effects on WCR and capex,
- social and supplier tensions,
- the debt structure in an environment of unstable interest rates.
That's why XVAL adjusted its models at the end of 2025 to incorporate all these inflationary parameters, based on the most robust academic research and feedback from the field.
The aim: to guarantee reliable, consistent valuation that is useful for decision-making, even in a context where prices are no longer stable.
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