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
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
- 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.
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
- 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
- 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
- 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.
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.