Higher interest rates can significantly impact the finances of your small or mid-size business. If you’ve been paying attention to the news, you’ve heard that the Fed has been raising the federal funds rate.
What’s the federal funds rate? It’s the interest rate at which banks lend money to each other overnight. When the Federal Reserve increases the federal funds rate, it has a significant impact on the cost of borrowing for individuals, businesses, and the government. In this blog post, we’ll explore how an increase in the federal funds rate hurts and helps small and mid-size businesses.
The Good: How Higher Interest Rates Help Small Businesses
What’s good about higher interest rates? Interest rate increases benefit small and mid-size business owners by increasing interest rates on savings, strengthening the dollar, and reducing inflation.
Higher interest rates on savings: After the Fed raises the federal funds rate, banks often pay more interest on savings accounts to stay competitive with other banks and attract deposits. If you maintain a healthy account balance, you could earn thousands of dollars per year on your savings. Are you tired of your large, national bank paying you next to nothing on your savings? Momentum CFO recommends checking Bankrate.com to find out which banks are offering the highest interest rates.
Stronger dollar: An increase in the federal funds rate can strengthen the dollar’s value relative to other currencies, which can benefit small and mid-size businesses that import goods or rely on foreign suppliers. Stronger currency means you can buy more with $1 today than you could when it was weaker.
Reduced inflation: A higher federal funds rate can reduce inflation, which leads to a more stable business environment. Taming inflation is the primary reason the Fed has raised rates in recent months.
The Bad: How Higher Interest Rates Hurt Small Businesses
There are several ways higher interest rates hurt small businesses. Rising interest rates impact you by increasing your borrowing costs, reducing access to credit, reducing profit margins, and reducing consumer demand.
Higher cost of borrowing: Small and mid-size businesses may face higher borrowing costs when the federal funds rate increases. Small businesses that have variable-rate sources of financing will undoubtedly face higher monthly payments. Higher monthly payments deplete cash, which could result in a cash deficit. If you rely on a line of credit, consult your CFO for assistance. A fractional CFO carefully monitors changes in interest rates and will partner with you to manage the financial impact of increased interest expense.
Reduced access to credit: As interest rates rise, banks may become more selective about which small and mid-size business they approve for a loan or line of credit. This can make it more difficult for you to finance operations or invest in growth opportunities. If your small businesses has less than stellar credit, it will be even more difficult to qualify for financing. The bank may also offer you less favorable terms, such as lower credit limits.
Reduced profit margins: Your profit margins may shrink as the interest expense on debt increases. In some cases, you may need to raise prices to compensate for the increased costs, which can make your business less competitive in the marketplace.
Reduced consumer demand: When the federal funds rate increases, consumers may have less disposable income to spend on goods and services. This can reduce demand for your products and services.
The Bottom Line
In conclusion, higher interest rates have both good and bad impacts on small and mid-size businesses’ finances. While higher interest rates on savings, a stronger dollar, and reduced inflation can be beneficial, businesses may also face higher borrowing costs, and reduced access to credit, lower profit margins, and lower demand. Small business owners must carefully monitor their finances and adjust their strategies accordingly.
Are interest rates negatively impacting your small business? Momentum CFO can help. Schedule a free consultation to learn how we can help you navigate increasing interest rates.