Back in 2017, I wrote an article for our blog titled “Interest Rates are Rising – Now What?”. When this article was written, the Federal Reserve was discussing interest rate increases of approximately 25 basis points quarterly to counteract a relatively hot economy at the time. During that time, employment was very low and the goal of the interest rate increase was to keep inflation in check in order to allow the economy to continue to expand. During 2017, inflation was still very low with a projected annual increase of 2% to 2.5%.
Fast forward five years to 2022. While the factor of low employment is consistent, what is not consistent is that inflation is running at greater than 8% and interest rate hikes are bound to be way more than 25 basis points a quarter. There is also talk as to whether the economy is at the beginning of a recession at this point due to inflationary factors and other economic indicators representing such.
After reviewing the previous interest rate post and what to do from 2017, some updates were made to reflect the current state of the economy. Most of the information from the 2017 post is still relevant, but there are a few “tweaks” to discuss as this rising interest rate environment for 2022 is much different than 2017. As a business owner, now is the time to review your debt structure and the interest rates on your business debt as well as how you manage excess cash. Here are some suggestions to consider to mitigate short and long term interest rate risk.
Review carrying cost of excess cash versus debt reduction
Many businesses have been able to or have taken an approach to build up excess cash over the last two years. Specifically with multiple rounds of stimulus, such as Paycheck Protection Programs loans, Economic Injury Disaster Loans and other federal and state offered grants, businesses have taken an approach to build up cash reserves to counter an unpredictable future forecast. Many business owners have used the excess cash and invested the funds into low risk performing bonds or investments that were yielding higher amounts than the interest carrying cost of debt with the intent of having cash reserves on hand to counter any further disruptions to the business operations from COVID shutdowns, supply chain issues or general employment matters.
Excess cash reserves can play a key role in any future business decisions within an increasing interest rate environment. The business’s ability to finance operations, capital equipment, and other business needs internally with excess cash will help maintain a stable debt structure for the business while also eliminating potential high interest rates on financing needs. However, there should be a balance between excess cash reserves and management of existing debt. With the interest rate market moving upward, if you have not done this already, now is the time to assess this strategy and determine if moving this excess cash into debt reduction makes sense in order to reduce future interest cost or if using excess cash reserves to internally finance operations and capital matters is a better choice.
Focus on paying down variable debt
Most business lines of credit (LOCs) are variable rate in nature where the rate is tied to the prime rate plus an additional rate charge (Prime +1% as an example). As the interest rate environment continues to increase, now is the time to focus on paying down this variable rate debt in order to save the interest cost on carrying the debt.
Consider refinancing to fixed rate loans
While both short-term and long-term interest rates have increased substantially over all-time lows as recently as 18 months ago, overall short- and long-term interest rates are still relatively low as compared to previous recessionary periods or periods of rising interest rates. Now may be the time to consider refinancing variable rate debt and debt with balloon and arm payments to fixed rate debt. By doing so, business owners can better manage the cost of debt by locking in a fixed rate principal and interest charge. This will help business owners to better manage cash flow in an increasing rate environment.
Now is the time to protect your business against a rising interest rate environment. By taking these steps to review your current interest rates and debt structure, business owners should be able to ensure they take advantage of current interest rates and to protect future cash flow from the rising cost of debt. Take the time to make a phone call to your banker to discuss your options and how to weather this rising interest rate environment.
If you would like to talk to one of our professionals in our Entrepreneurial Support & Client Accounting Segment on this topic or any other business related topic, please do not hesitate to contact us.