For over a decade now interest rates have taken a bit of a back seat when it comes to day-to-day business finance. In fact the availability of cheap money has helped many businesses ease the problems of cashflow and investment. But now rates are beginning to rise what effects are going to take place and what should business owners, senior managers and directors be looking at doing to reduce their effect? Our MD Darren Trice gives you a lead on what to expect and most importantly what to look out for.
Kaizen offers support and advice to businesses across a wide range of commercial operations not simply finance. From training to accountancy, operational improvement to executive management, branding to marketing strategy. Our philosophy is to orchestrate continual improvement within all areas of your business.
Background to what’s happened
On the 1st November the Bank of England raised interest rates by 0.75%, the biggest increase in 33 years and, with the new rate at 3%, this is the highest level since 2008. Since this article was written, the new rate has been increased even further to 3.5%. The Bank also said the economy over the next two years is going to be ‘under severe pressure’ and has said it will raise interest rates further if necessary. This all took place after the pound dropped to a record low against the dollar after the UK government’s “mini budget” in September 2022. Some financial experts estimate that the Bank will raise its base rate to as much as 6% by 2023 to try to manage inflation.
It was only in December 2021 that the bank rate was as low as 0.1%, so what has happened to cause this increase? Several factors have come together in a perfect storm, forcing the general interest rate level to rise. The economic environment was already feeling the pressure from demand rising as Covid restrictions eased, coupled with a supply chain that has been weakened by large parts of the economy having been shut down for so long. Recent events such as Russia’s invasion of Ukraine have increased this pressure and caused the cost of energy, food and other goods to rise sharply. This in turn contributed to a large hike in the rate of inflation, triggering what is now being called the cost-of-living crisis.
The current rate of inflation in the UK is around 10%, well above the 2% target that the Bank of England was working toward (see Stop Press at the end of this article for more information on forecasted inflation rates and growth). The aim for the government and central bank is to ease inflationary pressures by slowing economic activity. This is done through reducing demand and the main tool to achieve this is through interest rates. High interest rates deter people from borrowing on things like credit cards and loans and then spending what they are borrowing. High interest rates also deter businesses from buying and investing.
How will high interest rates affect your business?
Rising interest rates affect businesses in many ways, here are the three most important ways.
- Firstly, it can affect their turnover, as slower economic activity will lead to reduced demand for the goods or services they offer. Consumers will be reluctant to shop on credit as it will cost more, and business customers may prefer to keep their money in reserve rather than spend it
- Secondly, businesses will face higher borrowing costs and the extra interest they will have to pay will erode profit margins
- Even if businesses are not directly affected, they may still experience reduced turnover and demand due to the increased prices of goods from suppliers. They will be forced to absorb these increases leading to reduced margins or increase their own prices. This could push inflation even higher, further eroding sales and turning the whole thing into a circular downturn of cause and effect in effect starting and fuelling a recession.
There is still time for you to assess how rates might affect your business now and in the future. As a business you can then plan what you are going to do. For example, having a strategy of absorbing some of the increase based on affordability and passing on some of the increased costs as a price increase based on market competitiveness.
What can you do now
Because interest is charged on any debts you presently have or incur in the future you need to assess the type and levels of your debt you hold or are planning.
Businesses should be aware of the risks of overextending themselves when borrowing during a period of rising rates. With an increase in interest rates, businesses with company credit cards and existing loans such as overdrafts can be exposed to higher interest payments, which will result in less disposable income and reduced profits. In some cases, borrowers may find themselves paying off the interest only, rather than the loan amount itself, increasing interest costs over a longer term and storing up future problems.
Increased interest rates could also see businesses opting for shorter-term loans. These will affect things like cash flow and present greater risks leading to further negative impacts such as a shortage of cash to pay wages and suppliers.
Businesses need to keep an eye on the value of the pound and exchange rates. Higher interest rates often increase the value of currency so if businesses have income streams or buy materials in foreign currencies, then rising interest rates, and in turn the rising rate of the pound will affect profits. Forward contracts can be used to reduce the risk of exchange-rate differences where your business is involved in foreign currency transactions.
You need to keep a close watch on what is happening in your marketplace with both competitors and suppliers. Monitor any price increases and see if payment terms or accounts payable conditions change. You need to be aware that while you might be relatively free from interest rate rises, your customers may be affected and reduce their order levels or worse still increase payment times, both will affect your cashflow and profitability. Always take account of what is happening to your customers businesses in times like this because any reductions in demand will eventually feedback to you.
Even if your company has no borrowings affected by interest rate changes, your suppliers may do, and their costs to you may have to increase to cover the higher interest charges. Having contracts in place to fix supply prices can help reduce these affects at least in the short term. Also make certain you have sourced alternative suppliers to ensure you have a secondary supply chain just in case something goes wrong or changes with your prime suppliers.
Always remember, interest rate rises force companies to make decisions they wouldn’t normally want to, the situation is often out of their hands. When you combine inflation with interest rate rises you have a toxic mix which ends up increasing costs across many areas of business including manufacturing, distribution, and business services. These will all eventually trickle down the business supply chain resulting in increased costs.
So, you need to be even more vigilant during these times, paying attention to what is happening in the general economy, in your markets and with your customers, competitors and suppliers. Make all your managers and staff aware that information and intelligence on what is happening out there is key and hold regular meetings when things that are happening and their effects can be discussed. Use your external service providers, providers like Kaizen, to give you an analysis of your position and provide advice. Pay attention to financial news and read trade publications and visit trade websites regularly.
One thing that does happen in situations like this is that nobody is immune from the effects. Everybody suffers in some way, just make certain you suffer the least and you and your business will be healthy when things return closer to normality, and you can take advantage of the new opportunities that will give you.
If you want advice on how your business can ride through the effects of interest rate increases and grow stronger as a result, please get in touch with Kaizen for an initial no cost consultation on 01482 772271 or email us on email@example.com
The Chancellors recent Autumn Statement in mid November included the following forecasts on inflation and growth. These will be used by the central bank when setting future interest rates, watch out for more information on these forecasts in the coming months.
The OBR's forecast is for inflation of 9.1 per cent this year and 7.4 per cent next year, with inflation forecast to fall sharply from the middle of next year.
With the UK now in recession, GDP is expected to fall by 1.4 per cent in 2023 before growing by 1.3 per cent in 2024, 2.6 per cent in 2025, 2.7 per cent in 2026 and 2.2 per cent in 2027.