Rising Interest Rates, What Are the Effects?

As a business owner, it’s important to understand the effects on your business rising rates can have.

A rise in interest rates increases borrowing costs and credit risk for businesses. As well as potentially tough decisions within your business this can lead to a downturn in the economy, affecting consumer spending and capital investment further impacting business until the cycle returns to a lower cash rate. 

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Why do interest rates go up?

Interest rates are determined by factors such as inflation, monetary policy, and the monthly decisions made by The Reserve Bank of Australia (RBA).  

In basic terms, the determination of interest rates is influenced by various factors and is governed by the decisions made by the RBA. A high rate of inflation, as we’re experiencing now, will usually lead to a rise in interest rates as the RBA will lift rates in an attempt to lower spending and therefore bring inflation back to a more sustainable level.

The Effects of Rising Interest Rates on Business Loans

Interest rate rises can have significant effects on the borrowing costs of a business seeking a business loan. When interest rates increase, the cost of funding also rises, and this can have a direct impact on serviceability. A drop in serviceability directly impacts the borrowing capacity of a business and this in turn reduces the funding available whether it be for working capital, overdrafts, equipment finance or other forms of business loans.

This reduction in borrowing capacity has a direct flow on to the economy.  Whilst many industries have been affected, the construction sector’s well publicised challenges, where rising material and labour costs through inflation, combined with increased costs to funding have meant many businesses have gone out of business and many more are struggling to hang on.  Because of this increased risk many lenders have reduced their available funding to construction businesses and some have stopped lending to the industry completely.

As credit has become harder to get, some businesses have turned to unsecured lenders who can provide same day funding to plug business cash flow gaps.  Whilst this can be a stop gap solution it can further exacerbate future business cash flow challenges if repayments need to be made daily over short loan terms.

The Impact on Business Cycle

The effects of rising interest rates on businesses can be seen in the broader business cycle. 

With rising interest rates the cost of consumer lending, like home loans, also increases. As monthly home loan repayments increase the available money for discretionary household spending lessens and this leads to a decrease in consumer spending which slows the economy. As a result, businesses may experience reduced revenue, and this can ultimately lead to a decline in gross domestic product (GDP – a measure of the total value of goods and services produced within the economy).

When GDP declines, it often leads to a drop in capital investment by business. If the decline is severe enough, businesses may be forced to reduce their workforce or delay growth plans – further impacting the economy. In public statements, the RBA governor has talked much about how difficult it is to get monetary policy right at this time so as not to push Australia into recession.  

Can managing cash flow mitigate against rising interest rates?

Managing cash flow is an important aspect of financial management for any business, and it can help businesses to cope with rising interest rates to some extent.

How to profit from rising interest rates?Effective business cash flow management improves process, minimises bad debt and allows for better business planning.  Rising interest rates also adds to borrowing costs for business, cash flow forecasts should be updated to reflect this higher cost and managing to a budget could help business owners identify where they can make savings in their operations.

It’s important to note that managing cash flow is not a complete solution to interest rate rises. Rising rates still have a significant impact on a business’s borrowing capacity and profit and financial stability. If a business owner is concerned about their future ability to meet obligations it’s often easier to obtain credit before the situation becomes dire (and there will be more lending solutions and varying business lending rates available than if you wait until your situation is an emergency).

Disclaimer: This article is not meant as personal advice.  If you wish to speak to a business loan expert to discuss your circumstances please get in touch.