Beginning in 2008, financial crises drove down interest rates to just above 0%. Now, for the first time in almost 15 years, borrowing money is no longer “free.”
At the beginning of February, the Federal Reserve made its eighth interest rate hike in one year – and signaled several to come. Here’s how businesses should be thinking differently in the face of rising interest rates:
Aim For Shorter “Start Up” Periods
During the era of free money, it became the norm for startups to run for years without being profitable. The same could be said for introducing a new line of service into an existing business or other business expansion plans.
However, in the face of rising interest rates, it becomes more expensive for businesses and investors to borrow money, making longer start-up periods cost-prohibitive. In the face of rising interest rates, existing businesses looking to expand should plan to generate a return much more quickly than was previously acceptable.
Credit card rates are the highest they have been since 1996
Get and Stay Lean
When rates are low, the “cost” of having plenty of inventory, supplies, etc. is low. For the last decade or so, the economy was humming so most businesses were worried more about having product to sell than the interest carried on their balance sheet items. Things are different now.
One Lucrum manufacturing client is struggling with cash flow, but they have tons of WIP; both raw materials and in-process builds. If this client can figure out a way to shift to more of a “just-in-time” ordering scheme, or shorten the cycle time (the time it takes to go from raw materials to sale of the end product) it would dramatically improve their cash flow. At the same time, this would reduce their dependence on their line of credit which is costing a lot more than it did a couple of years ago.
Don’t Jump to Pay Off Fixed Low-Rate Loans
Financial advisors may give generalized “prioritize paying off debt” advice as interest rates rise, but this advice does not apply for existing low-rate fixed loans. Businesses would – for the most part – be better served by putting their money elsewhere (vs. paying off low-rate loans).
Instead, consider investing the money to generate a higher rate of return or using cash to pay down other higher interest debt (or avoid the loans in the first place). If the business is carrying a credit card balance, for example, use the extra cash to pay down that debt vs. the lower-interest loan.
Prioritize Paying Off Debt for Variable Rate Loans
While paying off previously obtained low-interest fixed loans may not need to be a priority, paying off existing variable-rate loans, such as business lines of credit, should be. In the past years, these loans may have been smart as they may have been at near-zero rates. However, these types of loans are risky to hold onto in the face of rising interest rates as they react quickly and greatly to market changes. Either aim to pay them off or convert them into fixed-rate loans.
Get Rid of Credit Card Debt
The same goes for business credit card debt – the rate will continue to rise alongside rising interest rates. And credit card rates are currently the highest they have been since 1996.
If possible, look at options for debt consolidation for the business under a lower-interest loan. For example, small businesses can look at SBA loans which usually have longer borrowing periods and lower interest rates.
This protects the business against volatility in card rates and prepares it for healthier cash flow management (that could otherwise be impacted negatively when increased interest rates suddenly begin to tie up too much cash on a monthly basis).
Know Your Options To Lock In the Best Deal
If the business has cash on hand, it may have options when it comes to today’s higher rates. For new purchases that carry a higher interest rate, the business may be able to use cash to buy down interest rates. Make sure to ask the lender what options are available.
Businesses may be able to use cash to buy down interest rates
Additionally, the business should shop around for financing and look at different lenders – just remember that those that are more flexible with their underwriting are typically not going to offer the best rates. Also, make sure that the business has its documents and business plan in order to secure the best financing options.
We recently heard of one client being offered a great interest rate or $5,000 cash discount. After running the numbers, it was clearly the better deal to take bank financing even though it was a higher rate. Another client was offered 6.75% from their bank only to have the equipment manufacturer offer 3.9%. The moral of the story is it pays to shop around before you make the purchase decision and be sure to go in armed with the facts beforehand.
It’s OK to Build Cash Reserves
With interest rates rising, the ‘penalty’ of having cash reserves is not as great. Businesses should consider investing cash in low-risk investments that now bring a higher return, such as CDs or, shocker- Money Markets. Yes, money market accounts are back- and actually paying a worthwhile return. Lucrum just got a 3.75% MM account on some reserves without having to lock the money away in a CD. Additionally, look at the business bank’s current savings account return – while these national averages are currently sitting at next to nothing (think 0.33%), some online banks may offer much higher rates to keep the business’ money with them (2%).
In addition to the ability to get more return on cash, businesses might need to increase their cash reserves to cover costs that would have otherwise been able to have been covered only by borrowing funds at interest rates so high that they could have negative impacts to cash flow.
Don’t Be Afraid To Enlist Professional Financial Help In Planning for Inflation
Rising interest rates make business planning more difficult. But there are options to tap into experienced resources to help you update your business plan to prepare for rising interest rates. Fractional CFO services are a good investment for businesses uncertain about how to navigate periods of high interest rates. These services can give business owners the confidence that they have evaluated the changing economic conditions from every financial angle and reduced risk as much as possible.