Trading in a rising interest rate environment

When interest rates climb faster than anyone predicts, cracks can appear. For example, if business owners find their loan repayment interest rate doubling in a few months, it will be problematic if they have tight margins. This is especially true when people have been happy to borrow, thinking the record-low borrowing and cash rates would hang around forever (or at least a few more years). On-going rising interest rates reverse this trend and can cause financial stress, where businesses have borrowed large sums of money, expecting interest rates to remain the same for a little longer.

Here are a few issues with rising interest rates for small businesses.

Customers spend less

Rising interest rates increase the cost of credit for both consumers and businesses. Your customers will be spending more of their earnings on interest, resulting in less disposable income. If you are in an industry deemed discretionary by the consumer, you could be the first expense to face the chop.

Other implications include:

• Higher interest rates make it more attractive for consumers with spare cash to save (they get a higher return on deposits). This takes more money out of the system.
• If many of your customers use financing (credit cards or pay later products), they may be reluctant to buy as much or as fast, as this cost of credit is also rising.
• The whole economy can slow. Siphoning off even a small amount of spending can starve other industries.

Harder to access credit

While higher business loan rates make long-term debt more expensive, short-term debt can also be harder to obtain. Lenders that require physical assets to secure financing will most likely want tighter requirements, such as more equity or personal guarantees. This increases the risk to you as the borrower.

Your costs go up

Most likely other costs to your business will also start to rise. For example:

• Your employees will probably feel the interest rate pinch if they have household debt. Their first port of call could be to ask for a pay rise, which increases your overhead. Even worse could be key employees leaving for higher pay somewhere else.
• If your business isn’t affected by interest rate changes, some of your suppliers, partners, or distributors most likely will be. As a result, they could be seeking to increase their prices to cover their margins and may want to negotiate new payment terms.

This inflationary pressure drives up the cost of the whole supply chain (manufacturing, distribution, services), which trickles higher expenses into your business.

The ultimate conclusion? You don’t want your suppliers to go bust, so you’ll probably need to accept their cost increases, which eventually forces you to increase prices to your customers, causing a possible drop in demand.

Predicting future costs is difficult

When interest rates change, you may struggle to know the cost of future borrowing or existing business loan rates. This can make it hard to plan your future finances and when to invest in new equipment or business growth.

Solutions to rising interest rates

If rising interest rates are causing you sleepless nights, then take action to reduce the impact. For example, identify if you can:

• Delay buying any big ticket items if they drain your cash reserves or require a big lump of debt. You may be able to get by for a time or think of a Plan B, such as repairing, renovating, or refurbishing.
• Refinance or close credit cards and any other higher-interest products you use. It may cost a little more in administration to track and pay for expenses as you go, but it could give you the breather you need.
• Refinance loans with a longer fixed term, protecting you against further increases outside your control.
• Tie new loans to known cash flow. If you have a new contract that lasts 3 years, any borrowing can be linked to that term. When the contract ends, so does the loan.
• If you’re planning to get a small business loan, do it sooner than later, especially if you can afford the repayments now and believe the interest rate increase will continue.
• Use forward contracts to lower the risk of exchange-rate differences if your business has foreign currency transactions.
• Talk to your suppliers to assess their exposure and how you can work together to offset interest rate increases. For example, having contracts in place to fix supply prices can reduce your risk of rising costs.

Next steps

Rate the risk your business faces with rising interest rates (low, medium, high) and then take positive action to reduce the chance this current trend will have on you and your business. Immediate steps can be to:

• Pay off any debt facing higher interest costs with spare cash reserves.
• Get advice from your accountant or financial adviser on the best ways to restructure your business.
• Investigate any local or federal government support you may be entitled to.