Fight High Interest Rates with Effective Cash Management
Inflation is a complex issue, and the only mechanism with which the Federal Reserve (Fed) can address it is interest rate adjustments. To slow the economy, the Fed began raising interest rates in March 2022. Since then, there’ve been 11 interest hikes to curb inflation.1 At 5.25-5.5%, the rates are higher than they’ve been in over 20 years.2
Such sweeping measures can upend business plans and forecasts, which are often based on inputs that include interest costs, as well as make cash management more difficult.
How do high interest rates affect businesses?
Higher interest rates may affect a business’s access to and use of both credit in multiple ways. Lending restrictions are often tighter during inflation which makes it harder for businesses to qualify for credit. For example, some lenders may require higher business credit scores to secure loans, lines of credit or credit cards.
Rising interest rates increase financing costs, making loans more expensive and potentially extending the necessary repayment period. Interest rate hikes also negatively impact a company's debt service coverage ratio, which includes the amount on hand to pay any principal and interest due.
Revenue and profit margins must keep pace to meet debt obligations. However, when interest rates rise consumers usually cut spending to reduce household budgets. If your industry or business caters to consumers, you may see a reduction in sales, revenue and profits. If so, debt repayment will limit cash flow.
Given the effect on consumer spending, loan costs and profitability, rising interest rates make it harder to set goals. Companies may need to re-evaluate and adapt their business plans to adjust to current economic realities.
Managing high interest rates requires insight.
During the pandemic, many companies saw cash reserves grow exponentially, so taking on new debt isn’t an issue for them. But that’s not true for all businesses. Depending on your risk tolerance, this could be either a suitable time to act or to wait for a clearer picture.
When interest rate hikes increase the cost of debt, you’ll face competing priorities ― sustaining or growing the business while defraying costs. In the short term, some companies may decide to pass along accelerating costs to customers. Others will choose to purchase “next-best” quality components or ingredients.
If high interest rates continue for an extended period, you’ll need to consider property, plant and equipment, as well as how to finance long-term assets and potential acquisitions. Of course, higher financing costs can have a negative effect on the balance sheet, increasing debts and lowering value.
How will you decide what’s the best move for your organization?
Informed cash management helps businesses face interest rate hikes with confidence.
Businesses always need to know how they are performing financially. This is even more critical when the economy is unstable. For instance, does spending align with revenue and are there opportunities to unlock trapped cash instead of applying for a loan?
A cash management plan will set guidelines for utilizing currently available funds and maintaining liquidity, as well as pinpoint opportunities for improvement. There are four elements of effective cash management.
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Assess current cash flow needs.
A cash flow analysis reveals how much your company earns and spend. You can identify income sources and available cash, as well as track expenses and payments over a defined period. -
Establish and maintain a budget to control expenses.
Budgets are necessary for financial stability, enabling businesses to track expenses and payments. In addition, budgeting will also uncover cash reserves, some of which might not be immediately visible. This “found” cash provides a cushion with which to pay down outstanding debt, reduce interest rate expense or plan for capital improvements. -
Minimize cash flow risks.
Periods of high interest rates are ideal times to review potential risks to cash flow, such as investments and debts, and tailor your strategy to the company's risk tolerance. Investing can provide a reliable passive income stream with the right portfolio allocation. However, some investment options offer higher potential for rewards but also increased chance of loss.
For example, savings accounts, CDs and mutual funds are reliable investments when loan interest rates are high. Short-term bonds, which are less sensitive to inflation than long-term bonds, may be good choices as well. Staggering maturities of investment instruments helps offset risks.
If you’re concerned about debt, meet with your lender to discuss refinancing options or better payment terms. Also consider loan consolidation. Similarly, vendors may be willing to renegotiate terms or offer discounts for early payment. -
Plan for future capital outlays.
The insights gained when evaluating current cash flow are valuable in forecasting future liquidity needs. Analyzing that data will help to answer questions like:
- What is the company’s operating cash flow ratio?
- How many weeks of liquidity does the company have?
- What capital projects will require funding?
- How are cash flow and capital needs increasing?
Scenario planning helps to anticipate future conditions and how they could affect your business, including financial impacts. You’ll know how to manage highs and lows.
To address the unpredictability of interest rates and the effect on your business, you must embrace a universal truth: no one can control the economy. However, you can manage information to make better spending and financing decisions. Get advice from trusted finance, accounting, banking and tax professionals. These experts can help further examine current and future business implications of your cash flow options.
Understanding your financial position and creating a solid cash management plan helps to mitigate interest rate hikes.
Contact a Synovus Commercial Banker for assistance or stop by one of our local branches for more details.
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Important disclosure information
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