Navigating the Future of High Interest Rates

High interest rates, at least in relative terms, are here to stay for the foreseeable future. And more increases could yet be on the way. We constantly hear from CEOs asking for our crystal ball, and many of them are uneasy about the interest rate environment. While the long-term effects of this are uncertain, business owners can act confidently by stepping back and truly understanding the impact on their business.

How is your debt structured today?

Lines of credit, which are almost always floating rates pegged to an index like Prime or SOFR, have increased in line with central bank actions. Should the central bank start cutting benchmark interest rates, those same lines would follow suit. Fixed-rate debt from a few years ago may actually look inexpensive in comparison. You may also need new financing. What is the current and near-term picture? For those businesses accelerating debt payments, does the current environment shift that strategy to different loans or even a pause altogether? While there are few general rules, a company with fixed debt at a relatively low rate may be well served to deploy capital in other areas of the business to drive returns rather than paying down debt faster. Alternatively, it might make sense to conserve more cash given continued uncertainty. The good news is that yields on cash are much higher as well. The answer is less important than the thought process that leads to it.

A great place to start is by modeling out your current and near-term debt and debt service, then playing with scenarios to see what further changes in interest rates might do. How material is it to your business? Do you have a debt renewal approaching? What is the impact if rates continue to increase? This answer is often surprising, both high and low. There is no reason to be nonchalant or fearful until the impact is at least quantified.

How much margin for error do you have in your business?

This is critical. Now that you know what the interest cost could be, how much can your underlying business absorb? A low-margin business is much more susceptible to changing variables. While high interest rates are unfavorable for most businesses, it could mean the difference between simply buckling down and weathering a storm in a safe harbor or seeing a small margin for error erode further, potentially necessitating immediate action like conserving more capital or deferring purchases.

How capital intensive is your business?

Companies that generate revenue from real estate, heavy equipment, and other long-term assets are very capital intensive and typically rely heavily on outside funds. These businesses are the most sensitive to interest rate changes, and an environment like this could easily make or break a deal. Manufacturing companies that need to invest in equipment or businesses with high levels of inventory and long-dated accounts receivable that depend on bank capital can also see significant impact. By proactively running the numbers, that potential impact can be quantified. It may necessitate shifts in strategy such as slowing innovation, revisiting terms, or even altering inventory purchasing.

What about your customers? Or suppliers?

Even after understanding the impact on your business directly, what about your key stakeholders? Do interest rates impact your customers’ ability to buy from you, leading to potential lost or deferred revenue? Might your suppliers get squeezed, causing them to tighten terms or possibly even disrupt your supply chain? Do you know how susceptible your customers or vendors are to interest rates? Understand their businesses as best you can before it’s too late.