Rising Interest Rates

MONEYSAVER

Start planning now for interest rate increases.

Historically low rates have encouraged borrowing for
equipment, real estate, operating lines of credit and
everyday purchases. How much longer interest rates
will remain at these levels is an open question but now
is a good time to start thinking about the potential
impact of higher rates on your business and
personal life.

Potential Effects of Higher Interest Rates

Here are some of the effects higher rates could have
on your business:

• Higher interest rates will drive up the cost of
  operations, manufacturing and delivery, which will
  force small businesses to either increase prices or
  face a smaller bottom line. If prices go up, consumers
  cut back their purchases if they need to borrow
  for vehicles and mortgages, or use lines of credit.
• Any resulting cash crunch may force customers to
  stretch payment time on their payables. This makes
  you your customers’ banker.
• Payout periods of as much as eight years for equipment
  and vehicles have led many purchasers to
  believe that if they can make the monthly payments
  they can afford the asset. But, as the years
  pass, the warranty expires, the vehicle value plummets
  and repair bills mount. It may be difficult to
  finance a replacement if a significant amount is
  still owing.
• Personal finances are affected as well. A salary
  increase decreases company profit while increasing
  personal income taxes.
• Financial institutions become more selective. New
  companies without credit ratings may find it impossible
  to obtain a loan. Established companies may
  not be able to extend lines of credit.

Review income statements and balance sheets.

Proactive Planning

The following suggestions may help reduce the impact
of rising interest rates on your business:

• Review your corporate income statements and
  balance sheets for the last five years because they
  reflect the lower cost of outstanding debt as well
  as the historical cost of your operating assets.
  Calculate the impact on the corporate bottom line
  if interest rates increase by two, three or more
  percentage points.
• Review your asset base. Determine what assets
  will need to be replaced within the next five years
  and estimate their replacement cost. If sales and
  expenses in the next five years remain the average
  of the last five years, would the increase in asset
  cost, combined with the need to borrow additional
  funds at higher interest rates, put undue stress on
  your operational capability?
• Review your personal debt at the same time as you
  review the corporate financials.
• Start building a cash reserve within your business.
• Consider reducing the long-term payouts on
  equipment and vehicles.
• Lock in existing secured loans.
• Lock in mortgages.
• Start incremental price increases to avoid a sudden
  and dramatic increase that may scare off clients if
  imposed later.
• Reduce the number of days outstanding for accounts
  receivable. Review your client base with the goal of
  reducing the lines of credit granted. Negotiate new
  payment terms with your long-term customers.
• Consider deposits on all jobs. Potential customers
  should understand that there are up-front costs
  that must be paid for, and that you are not a bank
  but a contractor.
• If your business has credit card balances or lines
  of credit with high interest rates, pay them off. If
  business credit cards are essential to your business,
  structure cash flow to pay off monthly balances.
• Use a percentage-of-completion method for payment
  on long-term contracts. If payment is not
  made as arranged, stop working. Better to walk
  away with a 20% loss then a 100% write off.
• Review all sources of company credit. Eliminate
  those with variable rates. Fledgling entrepreneurs
  should work to establish a line of credit with their
  financial institutions and increase it over time
  to ensure that in the future, that line of credit is
  still available.
• More established businesses should work to reduce
  the debt on their lines of credit in case a buffer is
  needed to meet short-term cash needs.

An Ounce of Prevention …

Should interest rates start to rise, the trend is likely
to continue upwards. Owner-managers should start
now to model their business activity in potential
future economic and credit conditions. Business plans
derived from these models will help ensure the continued
success of their business and family finances when
the 2020 decade rolls around.