Andrew Glaze, CFA is the CEO of Wealth Stack, which helps Veteran owned businesses access capital. He is a West Point and Columbia graduate.
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For any business, cash flow is the lifeblood of success. Too often, however, owners overlook how interest rates can play a major role in their capital structure and profitability. This oversight can have serious consequences for businesses in terms of increased costs, slowdowns in growth potential and reduced competitive advantage.
Investigating and taking control of your business’s approach to borrowing and financing opportunities should be one of the most important considerations when looking at increasing profits; it’s what I spend all day doing as the founder and CEO of a capital access platform and marketplace.
As I work with entrepreneurs and business owners daily, we spend a lot of time analyzing rising interest rates and how this could affect each business’s capital structure and ability to take on and finance debt.
Based on my work with other growing businesses and my background in investment banking, here is how interest rates can affect that process so you understand which strategies can help boost your company’s bottom line.
How Rising Interest Rates Can Hurt Businesses
As rising interest rates can have a significant effect on the cost of doing business, all businesses need to be aware of fluctuations in the rate. The key is to stay ahead and adjust your business model accordingly.
Reduced Ability To Service Debt
Rising interest rates can reduce a business’s ability to service debt, as rising costs are incurred by the organization with no corresponding increase in revenues to offset. Businesses may be placed in a precarious situation if too much of their capital is consumed paying off high-interest debt.
When these obligations take priority over investments in new products and services, or in marketing and advertising campaigns to increase sales, businesses may reduce their overall potential for growth.
In some cases, organizations may turn to cost-cutting methods like layoffs or reduced wages for employees to reduce fixed costs.
Slower Growth
When interest rates rise, businesses often attain slower growth rates due to the difficulty in getting access to lending as well as the higher costs associated with borrowing.
Accessing capital and funding opportunities is often essential for businesses when they seek to expand and grow, and when interest rates rise, the cost can become prohibitive. Business owners may choose to scale back their plans to ensure that short-term liabilities do not exceed their coming income. Together, these effects can serve to limit the growth rate of potentially successful endeavors.
How Rising Interest Rates Can Help Businesses
The spike in interest rates isn’t all bad, though. As the cost of borrowing money increases, rising interest rates can be beneficial for certain types of businesses.
For example, businesses that are in fields typically considered “safe” may benefit from rising interest rates if they have a large amount of capital or cash investments. These businesses may see their returns on investment increase as the value of their investments rise.
Here are a few other instances where higher interest rates can be beneficial.
Businesses With Floats
When interest rates rise, interest income for banks and institutions increases in turn. As such, a higher float could lead to greater returns when interest rates go up. Not only that, but it can also help them expand their business at a time when competitors are having trouble keeping up.
Businesses With Negative Working Capital
Likewise, businesses with negative working capital typically benefit from increasing interest rates as the negative working capital (a.k.a. excess cash on the balance sheet) earns a return. As a result, these businesses typically have more resources at their disposal for internal investment needs and other operational objectives. A good example of this is Booking.com or Expedia, which benefit from customers paying for vacations in advance.
Businesses With Positive Cash Flow
Businesses with positive cash flow can potentially benefit when interest rates rise because they can invest their positive cash flow into higher-yielding securities.
When the general interest rate in the market increases, businesses with positive cash flow can use this surplus capital to buy securities and investments that pay a higher return than before, allowing them to further increase their positive cash flow as well as maintain liquidity.
In general, by having positive cash flow, companies can have increased flexibility when it comes to dealing with potentially challenging economic conditions due to access to a greater variety of investment options that provide higher returns.
Identifying Your Capital Structure
Not sure how this affects your business’s bottom line? Identifying your capital structure as a business is one of the first and most important steps to understanding how interest rates can affect future growth.
Knowing the amount and kind of capital you are utilizing, be it earned or debt-based, will help identify where you are vulnerable and how any changes in rate structure may affect those operations. Additionally, having this information allows you to identify what areas could potentially benefit from higher interest rates, allowing your business to do more with surplus funds.
Ultimately, understanding your capital structure helps to identify, predict and influence the effect of fluctuations in interest rates on the overall success of your business.
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