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Inflation Adjustment Clause Definition

Inflation Adjustment Clause Definition

This is a finance-related clause in a contract. It adjusts the relevant payments based upon annual or periodic inflation.

A Little More on Inflation Adjustment Clause

An inflation clause is generally used to adjust prices or payments due. Simple calculations follow an inflation index; whole complex methods follow the combination of several indexes and prices. Generally, the baseline date must be set to start measuring the variability at the commencement of the contract.  

The more complex is the formula, often, the more accurate are the results. The level of complexity of the method is a matter of cost-benefit analysis.

This tool is essential in the negotiation process from buyers and suppliers point of view. From the buyer side of view, it is imperative to enable the buyer to determine and negotiate the correct adjustment clauses, because the price is derived through the adjustment will affect the cost and the profits of the company. While on the seller’s point of view, it is imperative so the supplier can determine the suitable evolution prices and it impacts the profits of the business.

Below are a few examples of products and services at a different level of complexity:

Where:


Cm = Monthly coefficient
LABORm = Value of the variable LABOR in the month of the adjustment
LABOR0 = Baseline value of the variable LABOR at the beginning of the contract
COOPERm = Value of the variable COOPER in the month of the adjustment
COOPER0 = Baseline value of the variable COOPER at the beginning of the contract
IPIMm = Value of the variable IPIM in the month of the adjustment
IPIM0 = Baseline value of the variable IPIM at the beginning of the contract
And finally, to get the Adjusted Price:
Pm = P0 x Cm
Where:
Pm = Adjusted price
P0 = Baseline price of the contract
Cm = Monthly coefficient

Not everything is about the formula.
Some of the essential factors to be negotiated in the contracts are explained below:

Begin by defining the starting point of any adjustments. This will be the baseline measure. The coefficient will then be adjusted for every payment or pricing period. Suppliers generally request adjustments monthly, while buyers prefer longer term adjustments (quarterly or yearly).

The whole formula will generally be subject to adjusted at any time. This is a common practice in long term contracts.
The conditions for adjustment differs in economies suffering fluctuations, particularly in long-term contracts. In any event, both parties must agree to any revision.
The Trigger clause is the provision indicating when an inflation adjustment must take place. It is usually set to take effect when there is some unforeseen variance in the variables.

References for Inflation Adjustment Clause


https://www.lawinsider.com/clause/adjustment-for-inflation
http://exclusive.multibriefs.com/content/supply-chain-negotiations-during-inflationary-contexts-adjustment-clauses/distribution-warehousing
https://www.bls.gov/opub/btn/volume-1/writing-an-escalation-contract-using-the-consumer-price-index.htm

Academic Research on Inflation Adjustment Clause

 

 

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