Changes in Federal Reserve interest rates can have a significant impact on small and medium-sized businesses. When the Federal Reserve raises interest rates, the effects are felt well beyond Wall Street. Businesses on Long Island may experience higher borrowing costs, increased operating expenses, reduced consumer spending, and greater difficulty financing expansion or managing cash flow.

An increase in interest rates can quickly affect business profitability regardless of whether it is a service provider, manufacturer, retail establishment or technology based.  Most businesses rely on lines of credit, commercial loans, equipment financing, or customer financing, each of which is affected by increased interest rates.  While businesses cannot control Federal Reserve policy, they can take practical steps to reduce their exposure and protect their financial position.

How Higher Interest Rates Affect Your Business

• Increased borrowing costs. Businesses with variable-rate loans, revolving lines of credit, or credit card balances may see their interest expenses increase. A higher cost of borrowing can reduce available working capital and make expansion, equipment purchases, and other investments more expensive.

• Reduced consumer spending. Higher interest rates can make mortgages, automobile loans, and credit card debt more expensive for consumers. As households have less disposable income, businesses, particularly retailers, restaurants, contractors, and service providers, may experience reduced sales.

• Higher costs of doing business. Businesses that depend on borrowed money to purchase inventory, maintain equipment, hire employees, or finance projects may find that their overall operating costs increase. This can be particularly challenging for businesses operating on relatively narrow profit margins.

• More difficult financing conditions. Banks and other lenders may tighten underwriting standards, require additional collateral, or become more selective when approving loans, including home equity lines of credit. Smaller businesses may find it more difficult to obtain financing or refinance existing debt.

Practical Steps to Protect Your Business

Business owners should consider the following steps to minimize the impact of rising interest rates.

• Review Existing Debt and Financing Arrangements: Identify all outstanding loans, lines of credit, credit card balances, and other financing arrangements. Determine which obligations carry fixed interest rates and which are variable. Pay particular attention to loans that are tied to the prime rate or another benchmark that may increase if the Federal Reserve raises rates.
  
  Research and evaluate whether refinancing variable-rate debt into a fixed-rate loan makes financial sense. However, compare the potential interest savings against closing costs, prepayment penalties, and other refinancing expenses.

• Reevaluate Your Line of Credit: A business line of credit is often essential for managing seasonal fluctuations and unexpected expenses. However, a variable-rate line of credit can become significantly more expensive as rates rise.
  
  Consider negotiating with your lender for a more favorable rate, exploring a fixed-rate borrowing option, or establishing additional credit availability to brace against financing becoming more restrictive. Businesses should also avoid relying on short-term borrowing to finance long-term expenses.

• Strengthen Cash Flow Management: Cash flow becomes particularly important when borrowing costs increase. Review accounts receivable and establish procedures for collecting outstanding invoices promptly. Consider requiring deposits, progress payments, or shorter payment terms for new customers where commercially appropriate.
  
  At the same time, review accounts payable and negotiate more favorable payment arrangements with vendors and suppliers. Maintaining an adequate cash reserve can help reduce the need to borrow at higher rates.

• Reassess Capital Expenditures: Before purchasing new equipment, expanding operations, or undertaking significant renovations, carefully evaluate the expected return on investment. Determine whether the expenditure can be postponed, financed on more favorable terms, or completed in stages.
  
  Not every investment should be abandoned because interest rates have increased. The objective is to ensure that the anticipated financial benefit justifies the increased cost of financing.

• Review Pricing and Profit Margins: Businesses should periodically evaluate whether their current pricing adequately reflects increased financing, labor, insurance, inventory, and other operating expenses.
  
  Where appropriate, consider modest price adjustments, eliminating unprofitable services or products, and negotiating better terms with suppliers. The goal should be to preserve profit margins without unnecessarily losing customers.

• Maintain a Relationship With Your Bank: Maintain regular communication with your lender. Businesses with established banking relationships, organized financial records, and a demonstrated ability to meet their obligations may be in a stronger position when negotiating financing arrangements.
  
  Do not wait until a loan comes due or a cash-flow problem develops before discussing financing alternatives.

Be Proactive

Interest rate increases do not necessarily signal that a business should stop investing or expanding. They do, however, make financial planning more important.

Business owners should consider preparing cash-flow projections under different interest-rate assumptions, evaluate their ability to service existing debt, and consider whether they could withstand a temporary decline in sales or an increase in operating expenses.

A business that understands its debt obligations, maintains adequate liquidity, and has access to reliable financing is better positioned to navigate changing economic conditions.

Our team at Campolo, Middleton & McCormick, LLP works with Long Island business owners to evaluate loan agreements, lines of credit, commercial leases, vendor contracts, and other significant financial commitments. Taking a proactive approach can help identify opportunities to renegotiate terms, minimize financial risk, and maintain flexibility as economic conditions evolve. To learn how CMM can help your business navigate changing financial conditions, contact Patrick McCormick at pmccormick@cmmllp.com.