Interest rates can be a good barometer for your business to either grow or pull back. Small and medium sized businesses often overlook the profound effect that broad economic influences can have. Yet, rising interest rates can be costly for businesses and the negative effects can be harmful unless you adjust responsibly to changes in the rate environment.
The business lending environment is shifting and the cost of business financing is currently rising. Let’s take a look at some of the negative effects rising interest rates will have on your business and what you can do to alleviate the impact. Will your business be able to not just survive, but thrive?
Borrowing Costs and Your Bottom-line
Banks essentially charge more for business loans when interest rates rise. In the end, businesses must use more of their earnings to pay interest on their loans. At the beginning of a rate-hike cycle, there may be positive benefits.
According to Briefing.com’s Chief Market Analyst Pat O’Hare, “the early part of a rate hike cycle should be beneficial to the consumer discretionary sector. Higher rates are presumably the result of a pickup in economic growth that is flowing from higher levels of employment, which creates a stronger sense of job security, higher wage growth and increased lending activity, and that leads to higher levels of spending.”
Nevertheless, businesses tend to pull back when interest rates begin to steadily climb and shelve their plans for new projects or expansion. Naturally, this constrains business growth. The times when interest rates are low and businesses can more easily borrow seem to be waning fast, with the US Federal Reserve indicating the potential for more increases to come. During a statement from the latest interest rate decision, the Fed projected three more rate hikes through the end of 2017.
If your business needs a loan, there are competitive lenders, but overall profits generally decrease with higher interests the longer business owner’s delay. Keep in mind that rising interest rates can often take up to a year or 18 months to have an effect. Ultimately, low-interest loans can fund business growth and increase profitability because businesses can earn a sufficient amount from new ventures to pay for the loan interest costs while still making a profit.
Generally speaking, your customers are likely going to have less money to spend when interest rates increase past the initial stage. Rising interest rates usually accompany higher inflation, which eats away at disposable income as prices for goods and services rise. Furthermore, it raises the costs for mortgages and can make housing a less affordable purchase over time. This means customers will have more expensive car loans, home loans and personal loans the longer rates continue to climb. This negative effect can begin to diminish a customer’s ability to buy services or products. Customers will have an amplified incentive to save rather than spend when interest rates increase.
Interest rates also influence consumer and business confidence which seeps into normal buying patterns. Other variables in the economy can be benefitted through with a rise in interest rates. Higher rates may have less impact on reducing the growth of consumer spending at times. For instance, if house prices rise quickly enough, people may continue to spend regardless of the rise in interest rates. All in all, businesses may begin to experience a drop in sales with higher rates as the adverse consequences with customer’s increasing snowball with the passage of time.
Business Crisis or Opportunity?
Businesses should secure loans as early as possible in a rising interest rate environment. Each quarter tends to become more expensive as banks and lenders fine-tune their lending policies. However, there are additional ways to lessen the impact of increasing rates by taking advantage of the flip-side and investing surplus cash and funds in interest-bearing accounts. While a rise in interest rates typically dampens appetite for risky investments, businesses can make money by saving as opposed to currently when rates are near rock bottom lows.
To avoid the worst and shuttering your shop, a business can keep profiting become resilient in these potentially unforgiving economic times of raising rates. Options for a business include taking a look at other strategies and tactics like reviewing your cash cycle management, requiring prepayments from customers, inventory management and shopping for short-term loans with low rates. However, it is not too late to lock in a loan for a low rate, especially with more rate hikes in the pipeline.