Any company’s survival depends on its ability to raise funds. Money is essential, but so is the ability to acquire loans at low-interest rates. The Fed can raise interest rates even more aggressively in 2022 after inflation increased by 7.5 percent in the previous year. This might be disastrous for businesses with slim profit margins, as a significant increase in interest costs could mean the difference between profit and loss. Fortunately, as a business owner, you may take steps to mitigate the additional costs that higher interest rates will entail.
What do increasing interest rates mean for your business?
Increased interest rates have a usually negative impact, which varies by industry. Higher interest rates may have the following effects on your business:
It will influence one’s ability to develop.
Increasing interest rates means higher loan payments. This is likely to result in a drop in profitability, making future finance more difficult to come by. Your firm may be forced to divert resources away from innovation and investment without these loans. Furthermore, you may be forced to delay investment and expansion plans, further impeding your company’s growth.
Cash flow will be negatively affected.
Because small businesses often have limited cash flow, cash flow contracts and additional income to repay other loans become rare when interest rates climb. This can make it harder to manage everyday expenses and create different financial difficulties over time, such as making short-term loans more expensive or difficult to qualify for to bridge any cash flow gaps.
- It will affect customer spending habits.
Changing customer spending behavior due to increased interest rates might impact your cash flow. When interest rates on loans such as mortgages and auto loans rise, consumers will have less discretionary pay to spend on goods and services. As a result, businesses, particularly those focused on the consumer, are likely to decrease sales, further compressing cash flow. Higher interest rates also make it more appealing for people and corporations to conserve money rather than spend it.
How do higher interest speeds affect your business?
Economic changes have repercussions. Interest rate swings affect how your business operates, how much money or sales you create, and how loyal and constant your customers are. The following is how it works:
Raised interest rates can limit your cash flow.
Increasing interest rates raise the cost of your company loan, forcing you to use more cash to cover interest costs. You may have less freedom to invest in long-term growth—or less day-to-day cash flow stability—depending on your company’s overall financial health and profit margins.
Growing interest rates can stop you from getting short-term credit
Long-term loans become more expensive when interest rates rise, but short-term loans become less available. The first roadblock is qualification. Short-term financing options like business lines and corporate credit cards may require even higher credit scores to get approved.
The second stumbling block is repayment. Even if you are approved for a short-term loan, the interest rate may be too high to afford, causing you to go further into debt. Your firm may struggle to remain ahead if you can’t afford to take on short-term debt to bridge a cash flow shortfall or deal with an emergency.
Increased interest rates curb consumer spending.
When interest rates rise, the average person’s minimum payments on school loans, auto loans, and mortgages must be increased. When money is fast, individuals cut back on their expenditures and start skipping certain things.
Relying on your industry and customer base, your services or goods may be the first things individuals cut from their budgets. As a result, customer retention and acquisition rates may decline, resulting in lower overall revenue and sales.
- Higher interest rates make it tough to plan
Because your company’s finances are the foundation of its operations, keeping track of your expenditures, cash flow, and earnings is vital. On the other hand, varying interest rates may throw even the most reasonable budgets into a loop. It may be more challenging to update your financial plan and prepare for growth as interest rates fluctuate, especially if you presently hold a variable-rate loan.
How to prepare for rising interest rates?
While interest rate hikes might be discouraging to the economy and businesses ability to generate money, they are necessary for the country to grow and function effectively. On paper, it sounds great, but when a business owner starts to feel the pressure from fewer customers and increased loan payments, the reality may be very different. The good news is that speed hikes are rarely unexpected; most of the time, there are many warning signs that rates are about to climb.
When things start to slow down, business owners can take the following steps to keep their operations healthy:
Hiring and employment
It may have been tempting to go on a recruitment spree to keep up with the company’s growth or strength in a low-rate market. Businesses want to hire people and contribute to their well-being, but it’s also essential to consider what’s sustainable and manageable when business slows. Operating at maximum capacity means different things for various companies, but the truth remains that slowing down your business is undesirable. It feels far worse to slow down your business and lay off staff.
Funds and growth
Businesses, like recruiters, may be driven to spend heavily on their operations when things are going well. When new clients arrive, they build new buildings, buy new equipment, and spend a lot on marketing and sales strategies. This intends to grow the company, but some of these activities have high costs typically covered by financing. While interest rates are down and cheap cash, things might change quickly. It is crucial to plan and invest just what is necessary to grow at a healthy pace. If the company cannot continue to develop without a new facility or piece of equipment, it is perfectly appropriate to invest in those items; nevertheless, keep in mind that these items will become more expensive as interest rates rise.
A checklist for businesses pondering the new world of rising interest rates
Evaluate your balance sheet for how much debt you’re carrying and how much financing costs can be tolerated.
Companies with variable-rate loans may have a more challenging time repaying them. Enterprises may have poorer profitability due to higher loan payments, making future financing more difficult to obtain. If these loans are not accessible, businesses may have to divert resources away from innovation and reinvestment.
Convert all or some flexible rate loans to fixed-rate, depending on how much you think interest rates will rise.
“If you think interest rates may climb somewhat, you can switch only a few loans to fixed rates,” Nadeau said. “You may wish to switch all debt to a fixed rate if you feel interest rates will climb dramatically.” He does warn, though, that a quarter-percentage-point hike, which is expected, will nearly double the one-month LIBOR rate, which has been growing for about a year. According to Smith, switching variable loans to fixed rates and entering into interest rate swap agreements are two ways to hedge.
Look at all other aspects of your business that could be affected by rate swings.
Interest rate swings have an impact on more than just loan costs. “Commercial mortgage rates will rise,” Nadeau said, “but the plant and office rentals may as well if the landlord’s borrowing costs rise.” “Because equipment and automotive leases are typically linked to interest rates, those costs may change.”
Audit your company’s cash flow history and your customer spending habits.
Companies with tight cash flow may find that the extra funds needed to pay off obligations are suddenly unavailable. Consequently, they may have to wait for receivables payment or investment and expansion plans, further reducing growth. Rising interest rates may shift customer spending patterns, affecting cash flow. Customers who must pay higher interest rates on personal loans, such as mortgages and auto loans, have less discretionary income to buy products and services. Higher interest rates encourage individuals and businesses to save money rather than spend it.
Consider how a stronger U.S. dollar will impact your business.
Because the value of the U.S. dollar grows in lockstep with interest rates, global firms must contend with the negative trade repercussions of a strong currency. “It’s not just selling globally; it’s competing globally, which most companies do nowadays,” Nadeau added. “As a result, those companies may want to talk to their banks about foreign currency exchanges and ways to protect themselves against the effects of a rising U.S. dollar.”
Effects on Employment
Increased interest rates have far-reaching consequences that go beyond loan pricing. When interest rates are low, people and businesses choose to spend rather than save their money. As money travels throughout the economy, many companies see the need to hire to fulfill the increased demand from so many new clients. The new workers then spend their newly discovered wages, and the cycle repeats. Rising demand for labor drives higher incomes, whereas increased demand for “things” drives higher pricing. This effect is tied to inflation, which causes the Fed to raise rates in the first place, but the cycle slows as rates climb.
As we all know, borrowing rates climb in lockstep with the Fed’s rate. This has a chilling effect on all spending and reinvestment, and many individuals may opt to retain their money in banks to benefit from higher interest rates. Hiring may fall marginally, and overall expenditures may fall as well. As interest rates rose in 2018, we may see some of this slower pace carry over into 2019.
Should you reach a business loan now?
If you’re contemplating applying for a business loan before interest rates rise at the federal level, be sure you’re accomplishing it for the right reasons. A business loan can help you stabilize or develop your firm, but only if you are in excellent financial standing.
Here are several reasons to get a business loan as soon as feasible before interest rates rise:
To lock in a more low-interest rate:
If you use a fixed-rate loan now, your interest rate will be locked for the loan duration, starting when you receive cash. You will be able to take advantage of the current low-interest rates, but you will also be able to save money and set yourself up for more predictable budgeting.
To invest in a growth project:
Perhaps you want to make a real estate investment or develop a new product. A loan may be advantageous if your finances are stable and you desire more cash to pursue an exciting opportunity.
To cover upfront costs:
A loan can help you get the finances you need to satisfy customer demand. Before a busy period, you may want to stock up on products, prepare your seasonal business for success, or purchase new equipment.
To refinance existing business debt:
Refinancing an existing business loan might result in a lower interest rate and more cash flow.
Before asking for a loan, consider your financial needs, company goals, and financials. Finally, you want a loan that will aid rather than damage your firm. As a result, it’s a good idea to put off asking for a business loan if:
- Your debt-to-income ratio is already high (DSCR). This is how you calculate your DSCR.
- You’re not earning enough money or selling sufficiently to pay off your debt.
- Your market or industry is in decline.
- You want to make a significant investment but don’t know how you’ll pay it off.
The business finance landscape is constantly changing. However, Federal Reserve statements and rapidly rising inflation figures have already carved the path forward in 2022. You must move immediately if your firm requires money since interest rates rise. Checking out all of your options, speaking with an expert in the industry, and moving quickly are all critical stages in ensuring that your company gets the money it needs in the most cost-effective way possible.