Allen Harris: How are higher interest rates affecting businesses? | company
The good news is that your input costs may drop enough to offset some of your rising labor costs.
The bad news is that your sales could fall due to higher interest rates.
The Federal Reserve is expected to raise the federal funds rate from 0 to 0.25 percent to 1 percent by July 2022. That doesn’t sound like a big raise, and it isn’t. But it’s fast.
The final rate is expected to be 2.5 percent sometime in 2023. Even this rate is relatively low. However, the super cheap cost of money has undermined the business environment by allowing weak and failing companies to operate.
A higher federal funds rate affects other interest rates, such as B. Mortgages, Wall Street Journal Prime and lines of credit. Many lines of credit are reassessed monthly, so higher interest costs are reflected immediately.
Some companies operate out of owner-occupied buildings, and those term loan payments could also adjust upwards. Higher interest rates affect your business’ cost of capital, which lowers cash flow. You’re wrong if you think that higher interest rates won’t hit you because you’re debt free. What affects your customers and the rest of the world affects you.
After the Japanese asset bubble collapsed in 1991, the government allowed banks to prop up so-called zombie companies by providing them with enough cheap money to pay off their loans. Two decades of easy money have spawned zombie businesses here in the US
There is no precise definition of “zombie company”. The Federal Reserve’s July 2021 report “US Zombie Firms: How Many and How Consequential?” states that “there is general agreement that these firms are not economically viable and survive by tapping banks and capital markets.”
Between 2015 and 2019, the Fed found that about 10 percent of public companies and 5 percent of private companies are zombies. Based on spikes during the US recessions of 2001 and 2008, I would make an educated guess that the numbers are double those reported for 2019 (and are even more dependent on easy money politics today).
The business cycle is linked to monetary policy. Marginal business practices have been effective because the low cost of capital has allowed for inefficiencies.
Despite these risks, the Fed intends to fight inflation by raising interest rates. According to the NFIB Research Foundation, the biggest problem for small business owners is no longer labor shortages, but inflation. Inflation recently hit 7.5 percent last year, the highest consumer price index (CPI) since February 1982.
Since 1977, the Federal Reserve has fulfilled a dual mandate defined by Congress to “effectively promote the goals of maximum employment, stable prices, and moderate long-term interest rates.” The Fed’s target inflation rate is 2 percent (using a metric known as personal spending). The next dragon to kill is high prices.
One reason for the high inflation is problems in the supply chain. The Fed cannot solve the supply chain problems that have contributed to inflation. However, the Fed can slow down the economy. Raising interest rates is a lever to get your customers to buy less of what you’re selling. Lower demand for goods and services drives prices down.
When interest rates rise, consumers tend to save more and spend less. Increased interest rates mean higher debt service fees. This restricts household spending on credit cards and borrowing, which means your sales and profits could fall.
The corporate sectors that will be hit first will be the most sensitive to interest rates. Mortgages are getting more expensive. Auto loan payments will be higher. Then it could spread to the rest of the economy.
Higher debt service eats away at profits and discourages companies from launching new projects or expanding because they cannot easily afford to borrow. You may not be that company, but the affected company or its employees could be your customers. That affects us. And once that starts, banks might hesitate to give you a business loan just when you need it most.
You can take steps now to prepare for how higher interest rates might affect your business. You should take steps to control rising costs and defend your earnings.
If your lender allows you, change your variable rate loan to a fixed rate loan. This secures your low interest rate for the life of your loan. If the lender doesn’t allow you to refinance, you can pay off your debt to avoid spending more at a higher interest rate. (Although you should consider the ratio of interest to principal payments in your amortization schedule.)
If you have excess cash, you can open a high-yield savings account to generate more interest income.
You can now have a line of credit approved. If your bank does not grant the loan, you can borrow against your investment portfolio. For example, Charles Schwab & Co. allows investors to enter into a “Pledged Line of Assets” to be “used for a real estate investment, business formation, or other expense.” Suppose the economy is weak or your borrowing costs are rising. In this case, it becomes more difficult to secure funding. It is better to have and not need than to need and not have.
Finally, change your customers’ spending habits. Pull some of your sales forward and make others recurring. This statement can (and has) stretched into entire books.
I understand that it borders on frivolity to suggest that this is as easy as waving a magic wand. I also know that the response from business owners across all industries is, “We can’t do this; You don’t understand my industry.” Well, I know the business. And I know tiny box owners often find themselves in it. This box limits opportunities to cut costs or defend revenue. Let’s get out of this box.