In May, the Federal Reserve announced its intent to reduce trillions of dollars on its balance sheet. The effort will be supported, in part, by a series of increases to the benchmark federal funds. While an interest rate increase can impact many areas of the economy for both borrowers and lenders, it can have a particular effect on small business owners. Here’s how.
Cash Flow Restriction
Cash flow is an important aspect of a small business’s financial health, especially for those that are seasonal in nature, or haven’t been open long enough to accurately predict and plan for changes in demand, revenue and expenses. Rising interest rates may increase price sensitivity by consumers, or lead to an overall reduction in consumer spending.
Rising interest rates can also increase business expenses associated with purchasing or leasing office or warehouse space, automobiles and equipment, or make it more difficult to sell assets at maximum value. Whether as a result of reduced revenue or increased expenses, businesses may find that their monthly cash flow is reduced when interest rates rise. If cash flow is restricted indefinitely, business owners may need to retool business models or reduce the size of their operations to accommodate cash flow needs.
Future Business Planning
Rising interest rates can lead to uncertainty about the future, for both businesses and consumers. Without the ability to reasonably predict future interest rates, small businesses may find it difficult to determine what risks they face in terms of reduced future demand, or increased costs of doing business. However, the Fed has shared its intent to raise interest rates. Small business owners can use the knowledge as motivation to take action, and determine how and when they will invest in growth and secure the financing needed to do so.
The Ability to Borrow Money for Future Expenses
Rising interest rates can be a double-edged sword for small business owners who seek funding. In one regard, rising interest rates could ultimately increase the amount of financing opportunities that are available to a small business owner; there’s more profit potential for financiers. Unfortunately, rising interest rates can also limit the amount of affordable options a small business has to consider when it needs to access additional financing.
Impact on a Business’s Current Debt
A small business with variable interest rate debt on loans, lines of credit or business credit cards could find it difficult to manage balances if rising interest rates lead to an increase on the cost of their debt.
On the positive side, however, small businesses can use rising interest rates as a cue to take action on opportunities they’ve postponed, including refinancing variable interest rate debt into a fixed rate product, or aggressively reducing balances on variable rate financing arrangements. Small business owners can also leverage the knowledge that rising interest rates are on the horizon to take the steps needed to establish and maintain a positive credit score. This can ensure they’ll have more access to competitive rates should they need to secure access to flexible financing, or plan for times of strained cash flow.