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How to prepare your business for interest rate rises

As the economy continues to improve, interest rates will need to rise. There is plenty of debate on when this will happen and by how much, and even the Bank of England does not seem too sure given the apparent signal to the market that rates would rise before the end of the year, and then a u-turn after this news spooked them.

One thing is for sure though; interest rates will need to rise at some point soon and more than once. Interest rates at 3% are certainly a possibility within just a couple of years.

Everyone has become so used to low interest rates, that the impact of increases could be significant for many businesses. Clearly the more debt a business has, the more significant this could be.

Rather than just wait for the effects of the rate rises, businesses should consider how this could impact the performance of their business. There are a number of areas to give consideration:

  • What will the impact be on the business as interest rates rise to different levels?
  • What will the impact be on the business’s customers as rates rises? i.e. the impact on demand
  • Will increased interest rates mean the owners of the business need to take out higher remuneration to cover their own personal needs?

What action should I take to protect my business from interest rate rises?

I always suggest modelling some numbers for the business based on the effect of increased interest rates. It doesn’t have to be an all singing, all dancing set of projections, but some simple numbers based on the additional interest costs and impact on demand and how they affect the profitability and cashflow of the business.

SMEs also need to look at the impact of increased costs and therefore profitability/cashflows in relation to any bank covenants in place. Again modelling these will show if there is likely to be any covenant breaches and issues going forward. It is always best to calculate these out yourself, before the bank do.

Funding deals should be looked at to see which are on fixed rates and which are on floating rates and therefore subject to change as interest rates rise. Work out at which level of interest rate it becomes a problem to the business. 

Once the numbers have been modelled and a business is aware of the impact on the business of different levels of interest rates, the options can be considered, which include:

  • Do nothing – for some businesses this informed decision might well be the right option.
  • Reduce/manage debt levels – this would be in order to reduce borrowing costs.
  • Fix all interest costs – given the market already prices in expected increases, fixed rate will be higher than they were some months or years ago, but they will still cap the borrowing costs.
  • Partially hedge interest costs – hedge some of the interest costs to protect the business.
  • Look at the wider business strategy – consider the strategy to find another solution if the debt cannot be reduced and/or increased interest costs is unavoidable. This will mean a more in-depth look at the business itself, its products, its marketing, its sales, its routes to market and its costs.
  • Expansion of the business – if debt and interest costs are not an issue to the business, the affect of rate rises on its competitors could provide a significant advantage to them.

For some businesses, the prospect of increased interest rates will be of major concern. These so called ‘zombie businesses’ are those that have survived the recession due to low interest rates and borrowing costs, are often loss-making and have been unable to reduce their debt. They will therefore be impacted more than most by higher interest rates. Naturally the improvements in the economy may help offset some of the increase, but depending on industry, business, and the speed of interest rate increases, this may not be enough.

The historic evidence shows that as the economy recovers, banks and creditors will tighten their views and take more and decisive action. This can also be seen in the insolvency figures, which after increasing in the time after the financial crisis, fell considerably and have stayed low, aside from some major retail casualties. Zombie businesses therefore need to take even more decisive action and quickly if they are to survive.

From a strategic point of view, if a business has no or low levels of debt, then increases in interest rates could put that business in a much more advantageous position than their competitors who may higher levels of debt and therefore affected more by the rise. Being aware of this allows a business to modify its strategy accordingly.

About the Author

Peter Black ACIB, AMCT, MBA has over 20 years of banking, finance and business planning experience and runs Snowball Consulting, a firm helping SMEs with strategic, funding and banking matters.

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