Interest rates have been at an all-time low for some years. Now that economies are showing signs of a tentative recovery, economists are starting to look ahead to an increase. What will a rise mean for your business?.
Any change in interest rates can have a mixed effect on a business depending on their circumstances and the sectors they work in. For example, a business whose customers tend to be in an older age bracket (and who are more likely to have substantial savings rather than large borrowings) are likely to find that business will improve with higher interest rates because their customer base will have greater disposable income.
An increase in interest rates also ensures that there is a greater likelihood of a business being able to secure a loan when interest rates rise, the rate of return improves for lenders and they can change their risk profile because a lot of higher return loans will pay for the inevitable small number of defaulted loans, on which the lenders will face losses.
The most significant impact on most businesses; particularly smaller businesses, is that interest payments create a sudden increase in costs, which will come straight off the bottom line. With many businesses making a 5% net profit or less, a change of 0.5% or 1% in the interest rate could make a significant dent in the net profit if the business is highly geared (i.e. if borrowings are a significant proportion of their working capital).
So what are the best ways to reduce this risk to your business?
- Run your business, if at all possible, cash positive. I.e. Keep money on deposit and don't borrow. If you have money on deposit, an increase in interest rates will provide you with a 'windfall' income and increase your profit rather than increase your costs and reduce your profit.
- Look at the interest rate offered by your bank or deposits and negotiate a better rate (or change banks) if it is not favourable.
- Check your ‘debtor days’ i.e. make sure that your customers do not exceed your payment terms.
- Consider shortening your credit terms for customers from, say, 30 days to 14 days and, if necessary, encourage early payment by offering a related discount.
- Make sure that you pay your suppliers in a reasonable time and in accordance with their payment terms but negotiate favourable terms for doing so, perhaps in the form of discounts. Do not pay your suppliers more quickly than you need to, because this has a negative impact on you your cash flow.
- If you cannot manage your business in a cash positive way, consider the type of borrowing or finance that you need very carefully.
- Remember: Overdraft facilities with a bank are useful if you have occasional, short term cash shortages, but NEVER use these facilities constantly as this is usually one of the most expensive ways to borrow money.
- If you need longer-term finance, shop around as the terms can vary significantly. Make sure that there are no penalties for paying the loan off early, just in case you have a windfall of profit or want to switch your loan at any point to a new lender.
- Try and reduce your stock (or work-in-progress if you are a service business) so that you do not have money 'tied-up' and not doing anything for your business.
- Consider whether it is worth getting rid of any customers that you cannot make a profit from.
- Consider increasing your prices. At a time in which interest rates are rising, 80% of customers will accept the fact that prices will rise; remember, they will also be experiencing changes in their financial circumstances, often for the better.
Stan Hornagold is Director at Stay Out Front and RICS Executive Education faculty member.
Find out more about RICS Executive Education’s Strategic Finance Masterclass and Business Management Masterclass and how we are supporting professionals in the built environment to position themselves as leaders in their industries on the RICS Executive Education website.