How Will Higher Interest Rates Impact Small and Mid-Sized Businesses

You can’t go anywhere these days without hearing about inflation. In simple terms, it is caused when we have too little supply to meet increased demand for goods and services. And while the U.S. Federal Reserve can’t do much to fix the supply issue, it can help stabilize the economy by raising interest rates to encourage more saving and less borrowing.

In an attempt to decelerate inflation, which is at its highest point in 40 years, the U.S. Federal Reserve raised interest rates by .75% on July 27, the fourth rate increase this year and the 2nd .75% rate hike in two months. This will bring the rate that banks charge each other for overnight borrowing (baseline rate) to a range between 2.25% and 2.5%. An earlier rate hike of .75% occurred in June 2022 which brought the baseline interest rate to 1.5 – 1.75%, the largest one-time increase in its rate since 1994.

Due to this increase, the prime lending rate jumped to 5.5%. Remember, that the prime rate is typically considered the floor of what commercial banks charge their customers with the highest credit ratings, typically large corporations. All of the rest of us can expect to pay prime plus a percentage based on the type of loan, its length, the credit score of the individual or business borrowing, and other dynamics.

Most experts warn there will likely be more rate increases if inflation doesn’t start to slow down. With this in mind, we wanted to take a look at how these rising interest rates can affect small and mid-size businesses and what you can do lessen its impacts.

What Higher Interest Rates Can Mean for Businesses

Consumer spending will decrease

No one is immune from Inflation and higher interest rates, and many people are looking for ways to cut their expenses. With higher prices on nearly everything, more disposable income has to go to necessities – food, housing, gas, utilities – leaving less money to spend on restaurants, travel, entertainment, and other things we can live without. Depending on your target market and the industry your business is in, this decrease in demand can negatively impact your cash flow.

Loans will be more difficult to get and repay

The cost of borrowing with current interest rates is much higher and sometimes even prohibitive, yet many businesses live and die by their lines of credit and short-term loans. Additionally, some companies were forced to take out adjustable-rate loans to survive the pandemic and are now faced with much larger payments than they expected. Higher interest rates also mean borrowers can expect to face greater scrutiny when applying for a loan since the chance of default is higher during inflationary times.

Expansion plans may need to wait

As we mentioned above, if sales decrease, cashflow is negatively impacted. Add to that a rise in the cost of materials and labor, and suddenly your financial picture looks much different than it did around this time last year. Businesses caught in the middle of these trends may have to put off expansion plans, such as building a new plant or adding a new service line. This, of course, will impact hiring as well, which further exacerbates the overall situation and reduces the money consumers have to spend.

Keeping cash on hand may get harder

Just like people, businesses should always have money set aside for a rainy day. Every company needs some accessible cash on hand in case something unexpected happens or an opportunity arises. But when you are selling less of your products or services, and paying more for the materials to make them, or people to deliver them, this becomes harder to do as more cash gets tied up in running the business.

Retaining your employees can be more challenging

No one is immune from the impact of inflation and higher interest rates, and that certainly includes your employees. When more of their money has to be used to meet basic needs –much less indulge on things they want to do or buy – they are more likely to look for ways to bring in more money. This could include asking for a raise or jumping at a better job opportunity that comes their way. To remain competitive and hire and retain the best team possible, you may have to increase what you pay current employees or offer new hires.

What Can Businesses Do to Lessen the Impacts of Higher Interest Rates

Reassess your business plan

There is no time like the present to take a fresh look at your business plan and decide if it needs to be adjusted based on the economic environment and your specific industry. Is your cash flow healthy enough to keep you afloat? Are your profit margins on the products or services you sell where they should be? If your margins are waning in some areas, you may want to focus the lion’s share of your marketing and sales efforts where you are making more money. By selling more high-margin goods or services, your cash flow will remain healthier.

Take a fresh look at your loans

Do you have any adjustable-rate loans or expensive lines of credit? With interest rates predicted to continue rising, money is probably cheaper now than it will be later this year or next. Consider securing fixed rate loans to replace any variable rate ones, and consolidate where you can to see if you can qualify for a lower overall rate.

Increase your prices

While this has to be handled carefully and may not be an option for every business, it should be considered. If your raw materials and payroll costs have gone up, it may be time to charge more for what you do. For some, small, incremental increases are easier for your customers to bear than larger surges. Look at the impact a price increase will have on your clients and weigh the pros and cons of different price escalations.

Analyze your fixed costs

While certainly harder to cut, sometimes there are areas where even your fixed expenses can be reduced. For example, would a hybrid work model where employees work 2-3 days at home each week allow you to reduce your office space? This could save on rent as well as utilities.

If you are concerned about how higher interest rates may impact your business and its ability to generate a profit, we are happy to review your specific situation and make some recommendations. Reach out to us if you’d like to schedule a consultation.

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