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Rising Interest Rates - Madan CA

Rising Interest Rates

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MONEYSAVER

Start planning now for interest rate increases.

Historically low rates have encouraged borrowing for
equipment, real estate, operating lines of credit and
everyday purchases. How much longer interest rates
will remain at these levels is an open question but now
is a good time to start thinking about the potential
impact of higher rates on your business and
personal life.

Potential Effects of Higher Interest Rates

Here are some of the effects higher rates could have
on your business:

  • Higher interest rates will drive up the cost of
    operations, manufacturing and delivery, which will
    force small businesses to either increase prices or
    face a smaller bottom line. If prices go up, consumers
    cut back their purchases if they need to borrow
    for vehicles and mortgages, or use lines of credit.
  • Any resulting cash crunch may force customers to
    stretch payment time on their payables. This makes
    you your customers’ banker.
  • Payout periods of as much as eight years for equipment
    and vehicles have led many purchasers to
    believe that if they can make the monthly payments
    they can afford the asset. But, as the years
    pass, the warranty expires, the vehicle value plummets
    and repair bills mount. It may be difficult to
    finance a replacement if a significant amount is
    still owing.
  • Personal finances are affected as well. A salary
    increase decreases company profit while increasing
    personal income taxes.
  • Financial institutions become more selective. New
    companies without credit ratings may find it impossible
    to obtain a loan. Established companies may
    not be able to extend lines of credit.

Review income statements and balance sheets.

Proactive Planning

The following suggestions may help reduce the impact
of rising interest rates on your business:

  • Review your corporate income statements and
    balance sheets for the last five years because they
    reflect the lower cost of outstanding debt as well
    as the historical cost of your operating assets.
    Calculate the impact on the corporate bottom line
    if interest rates increase by two, three or more
    percentage points.
  • Review your asset base. Determine what assets
    will need to be replaced within the next five years
    and estimate their replacement cost. If sales and
    expenses in the next five years remain the average
    of the last five years, would the increase in asset
    cost, combined with the need to borrow additional
    funds at higher interest rates, put undue stress on
    your operational capability?
  • Review your personal debt at the same time as you
    review the corporate financials.
  • Start building a cash reserve within your business.
  • Consider reducing the long-term payouts on
    equipment and vehicles.
  • Lock in existing secured loans.
  • Lock in mortgages.
  • Start incremental price increases to avoid a sudden
    and dramatic increase that may scare off clients if
    imposed later.
  • Reduce the number of days outstanding for accounts
    receivable. Review your client base with the goal of
    reducing the lines of credit granted. Negotiate new
    payment terms with your long-term customers.
  • Consider deposits on all jobs. Potential customers
    should understand that there are up-front costs
    that must be paid for, and that you are not a bank
    but a contractor.
  • If your business has credit card balances or lines
    of credit with high interest rates, pay them off. If
    business credit cards are essential to your business,
    structure cash flow to pay off monthly balances.
  • Use a percentage-of-completion method for payment
    on long-term contracts. If payment is not
    made as arranged, stop working. Better to walk
    away with a 20% loss then a 100% write off.
  • Review all sources of company credit. Eliminate
    those with variable rates. Fledgling entrepreneurs
    should work to establish a line of credit with their
    financial institutions and increase it over time
    to ensure that in the future, that line of credit is
    still available.
  • More established businesses should work to reduce
    the debt on their lines of credit in case a buffer is
    needed to meet short-term cash needs.

An Ounce of Prevention …

Should interest rates start to rise, the trend is likely
to continue upwards. Owner-managers should start
now to model their business activity in potential
future economic and credit conditions. Business plans
derived from these models will help ensure the continued
success of their business and family finances when
the 2020 decade rolls around.

 

Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.

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