Rising interest rates can have a significant impact on various aspects of our financial lives. From mortgages to credit cards and savings accounts, the effects of higher interest rates can be felt by individuals and businesses alike. However, there are some practical steps that your business can take to mitigate the potential negative impacts of rising interest rates. We will explore some of these below.
1. Assess and refinance existing loans
This is one of the first things you can do with the quickest potential results. Look at the different debt you may have outstanding, each with its own respective interest rate, and look into potential refinancing options which may yield a lower overall interest rate than the combined interest currently being paid on multiple loans.
2. Prioritize high-interest debt
Once you have restructured any debt that you may have, then look at what is left and tackle the higher interest debt first. This is the debt that will have the higher debt servicing costs, or overall interest over the course of the year. Hammering away at that first will reduce the higher interest costs, thereby freeing up more cash flow to then tackle the lower interest debt.
3. Review your budget
If you do not yet have a budget for your business, now is a good time to get started. Your budget will help you think through your revenue sources and what to expect in the year to come, as well as your expenses, and what you are spending money on and why. In the context of business, you want to think of money spent as an investment and, as a result, consider the return on the investment of each dollar spent. Be aware of dollars that are spent unnecessarily, without consideration for potential return, as that is the spending that can erode your bottom line.
Once you have your budget in place, be sure to track performance against your budget, as this will help you know if you are on track, or if your initial budget assumptions were not realistic. It also helps with making decisions about discretionary purchases, as being close to or over budget may result in deferring some of those purchases for the time being.
If you budget effectively, and monitor your budget closely, this should help avoid excessive spending, which helps minimize the need for unnecessary debt (such as using operating lines of credit without intending to), which will likely be subject to the risk of rising interest rates. There are times when utilizing operating lines and other financing options is necessary; we are talking here about avoiding using these unnecessarily.
For more information on budgeting for your business, and budget variance analysis, please check out our budgeting webinar replay here.
4. Know your pricing, costs, and profitability While closely tied to budgeting, this has more to do with understanding the profitability of your products and services. Know your input costs, understand your pricing strategy, and know your break-even point. Being informed and intentional in this area will help ensure profitability of your sales, and will help avoid losses you may be unaware of, such as products or services that are actually sold at a loss and are therefore cannibalizing the profit of your other products or services. Sometimes this may be intentional, but it requires knowing your numbers to make that intentional decision; do not have it happen without being aware of it.
Once you understand the drivers behind your profitability, you can begin to impact those more proactively, both on the pricing side, in terms of strategic pricing approaches, and on the cost side; whether that be by sourcing different inputs, negotiating with existing suppliers, or optimizing your operations.
5. Improve working capital management
The working capital of your business is the difference between your current assets (such as cash, accounts receivable, inventory, etc.) and your current liabilities (such as accounts payable, taxes payable, current year debt payments, etc.). Businesses that have a difficult time managing their working capital may find a greater need for financing to cover operations, such as through the use of an operating line of credit. While it’s not uncommon for businesses to use an operating line of credit, it’s important that the use of debt financing be done intentionally, and with planning, as having to do so in a bind typically leaves you with fewer options, which typically makes the cost of borrowing higher, and the lending terms more restrictive.
Here are a few ways in which you can optimize your working capital management:
Work to decrease your Accounts Receivable collection period.
Here are a few ways this can be done:
Implement efficient invoicing systems, so invoices get to clients quickly, thereby decreasing the time between the sale and when you are paid.
Be more selective to clients you grant credit terms to.
Be proactive in the collection of aging receivables.
Ensure your business is easy to pay. Accept payment methods that allow for quick payment of your invoices (this helps avoid waiting for that “cheque in the mail” for weeks).
Be careful with your inventory management. Look at how long it takes to turn your inventory over, and be diligent in not ordering too much inventory that will sit for longer than is necessary, as that is similar to taking cash you could otherwise use and locking it in a drawer unnecessarily. Look at the demand of your products, and order your inventory accordingly, to optimize the balance between having what it is your customers want, when they want it, and not holding on to inventory longer than you need to (which also runs the risk of inventory write-offs, through obsolescence, damage, or loss).
Look at increasing your Accounts Payable period. This may be done a few different ways:
Establish credit terms with vendors you currently pay at the time of purchase.
Negotiate longer payment terms with existing vendors.
Implement cash flow forecasting. This helps you have a better pulse on when payables need to be paid, allowing you to not pay until you need to, while still maintaining strong relationships with your vendors, avoiding late-payment penalties, and being aware of any potential cash constraints well before they happen, so that you can be better prepared for them.
Click here to download our free eBook on managing cash flow.
6. Ensure timely payment of bills and taxes When your accounting and record keeping is kept up to date, your business is well positioned to ensure timely payment of your bills and taxes. Paying your bills on time will help maintain strong relationships with your vendors and will help avoid any late payment fees and interest. Similarly, paying your taxes on time will also help avoid penalties and interest on late payments. At the time of this post, the CRA interest rate on overdue taxes is 9%.
For businesses that use automated payments, this can be another helpful way to ensure that recurring bills are paid on time.
General Finance Tips In The Context Of Rising Interest Rates
It is important to recognize that perceived risk for lenders also goes up as interest rates go up, as the ability for borrowers to service existing debt (maintain payments) in the context of rising interest rates comes more into question. Therefore, if you are entering into new loans in the context of rising rates, you may find tighter constraints on how much can be borrowed, and a default to more restrictive terms and covenants relating to your loans. As is usually the case, strong relationships are key to good business, and so maintaining a strong relationship with your lender(s) can go a long way when it comes to navigating debt in a rising interest rate environment.
Lastly, debt is not necessarily a bad thing. It can be a very helpful resource. With interest rates having been so low, it has been cheap for quite a while to take on debt. Rising debt servicing costs (with rising interest rates) requires more careful planning for larger purchases that may involve debt. If you have any questions about anything covered here, or if you need help with analyzing your profitability, business performance, or in making a large capital expenditure decision, please let us know.
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The information above is intended to be of a general nature, and is not intended to address the circumstances of any particular individual or entity, and is not able to capture changes that may be enacted that would impact the information above following the date of publication. As such, there is no guarantee that the information above is accurate as of any given date following publication, and so no one should act on or make specific decisions based on the information above without first receiving professional advice that can take into consideration specific circumstances for each person. Should you wish to discuss your specific situation, you can contact us here.