Brian Wallace
Nearly everyone across the economy has been impacted by high interest rates. Between March 2022 and July 2023, the U.S. Federal Reserve raised interest rates 11 times and pushed their benchmark rate to a 23-year high. Since last year, rates have remained unchanged, but incoming economic data suggests that the central bank may begin cutting rates in the months ahead.
Higher interest rates usually increase the cost of borrowing and financing debt. For consumers, this might mean that taking out a large loan to purchase a house will be a lot more expensive compared to when rates are low. Similarly, business loans become more costly to finance, resulting in slower innovation and business expansion.
However, these are temporary conditions, and new data suggests that inflation continues to trend downward, which could help usher in rate cuts. For businesses, lower interest rates can help spark new economic activity, in turn helping business owners leverage long-term financial opportunities to grow their business or invest in new products and services.
How Falling Interest Rates Can Benefit Your Business
Interest rates can have a complicated impact on your business. Higher rates typically raise your debt cost, while lower interest rates could mean that your company can invest in new ventures. There are a mix of benefits that come with falling interest rates, and here are just a few you can consider.
Increased investment spending
One business area that sees an increase in interest during a falling rate environment is investment spending. This activity may include internal investment, either from an owner or angel investor or perhaps venture capital-backed investments.
As capital becomes more affordable, owners and investors tend to become more eager to invest in future opportunities of the business or take ideas to the next level of development.
Typically during high interest rate periods, investors are slower to take on new risks. For example, in the third quarter of 2023, fund formation declined to its lowest since the first quarter of 2022, and ranked as the worst-performing quarter since 2017.
Improved consumer optimism
Individual consumers are the most impacted by higher interest rates, and can often lower their economic confidence. A low economic confidence often results in slower spending, more consumers saving, lower credit card purchases, and decreased loan activity.
Though a cut in interest rates doesn’t automatically send consumers back, a gradual decline can help improve sentiment regarding future economic prospects and near-term financial objectives.
Decline in costs
By some measures, falling interest rates could indicate that inflation has cooled and that costs are trending downwards. To control rapidly rising prices, a central bank may lift interest rates to contain an overheating economy.
In this instance, we’ve seen inflation falling from its peak of 9.1% in June 2022 to 2.9% in July 2024. Though this is still above the Federal Reserve’s 2% target rate, declining inflation could help provide a more confident outlook regarding prices and the cost of goods and services.
While higher prices have affected everyone across the economy, moderate inflation coupled with softener interest rates could help spark economic activity among consumers and businesses.
Lower capital costs
In ordinary times, such as when interest rates are low, taking on new debt can be more affordable for a business. Financing new debt means that a business can afford to take on larger risks, while simultaneously expanding business operations.
In a high interest rate scenario, banks will charge more for loans and make accessibility harder on new applicants. This could lead to a business having to raise its margins to afford new capital, which results in the business raising its prices.
In some instances, banks could charge higher interest on loans but offer more favorable deposit rates for consumers and businesses based on the CD rate history from the last several decades.
Better business valuation
During a period of high interest rates, investors take a slower approach to investing in new companies, startups, and scaleups. This decline leads to an overall decrease in business valuation, which could make a business look less attractive to prospective investors.
However, this cycle begins to reverse when a central bank begins to cut back its benchmark rate. Some investors might see new opportunities, which might see them finance new debt or raise their risk exposure.
Five Ways To Prepare Your Business For Rate Cuts
Current headlines suggest that the Federal Reserve is projected to begin cutting interest rates before the end of summer. Although they haven’t indicated whether they will cut rates again before the end of 2024, businesses can use this opportunity to strategize and begin planning for the road ahead.
Take stock of your finances
With rates expected to come down, it’s time to take a look at your finances. You might have spent the last several years holding back on taking on new debt, but now might be the time to begin evaluating your position and consider your long-term outlook.
By taking on your finances you can start logging your fundamentals – expenses, losses, profits, inventory – in one place, which in turn could make things easier for you should you have the capacity to apply for financing.
You’ll be expected to provide a stack of important financial information to your lender, so having everything ready and in one place could help make the process a lot easier. On top of sorting your fundamentals, this process could give you a new perspective on your business finances, and see where you could be making necessary adjustments.
Adjust your margins
Nearly every business has raised their prices in recent years. Many have done so to make up for higher labor and supply costs, while some raised their prices to adjust for a higher margin.
Price increases are a simple way to increase your margins and boost profitability. During high interest rate periods, a business might consider reducing low-margin activities, and rather focus on products or services that can provide them with more favorable margins.
However, a shift in the wider economy could provide you an opportunity to adjust your margins, especially for products or services that you have removed in the past. This could help you create another revenue stream in your business, which in the long run can help bolster profitability.
You don’t have to go out of your way to find products and services that can bolster your bottom line. Instead, focus on existing high-margin activities, but keep in mind how other revenue streams can help improve profitability.
Keep paying off expensive debt
Having business debt is normal, however many small-medium businesses tend to take on large quantities of credit card debt during periods of financial distress. Many businesses will often charge smaller expenses on a business credit card, however, one small purchase after another can quickly add up.
In fact, around 44 percent of businesses charge half of their spending on credit cards, with at least 30 percent of businesses charging a robust 26% to 50% of spending on their business credit card. More concerning, approximately 46 percent of business owners with a business credit card don’t consistently pay monthly balances.
Debt in any form is a financial burden for your business, and the faster you repay expensive debt, the quicker you can write off these expenses, and instead use that capital to invest in other facets of your business.
Draw up an investment plan
Perhaps the news of a softer interest rate outlook came at the appropriate time for your business as you’ve been looking to expand or incorporate new additions to help increase your capital streams.
Should your business be in a comfortable position to take on debt to fund new ventures, begin drawing up an investment roadmap that will help you highlight your key objectives and what you will be doing to accomplish each step.
You will have a clearer understanding of the road forward as conditions unfold, but it’s important to keep an open mind and have a flexible approach that allows you to make adjustments to your investment strategy.
Create a forecasting model
Something important to keep in mind when planning for the months and years ahead is your forward-looking approach to taking on new business and resolving current challenges. Every business owner will have a unique set of business needs they are looking to fulfill, however, without the proper guidance or roadmap, these milestones will become unachievable.
Your forecasting model should provide you with an analysis of your current business strategy, how a changing rate environment will provide you with more business opportunities, and what is required from you to fulfill these needs.
For instance, you might be thinking of expanding your supply chain, which could mean that your logistical team will need to grow. This not only means you need to hire an additional employee, but you will need to think about the onboarding and training process and the type of person you want to have as part of your business.
These are all small things that can quickly add up. Planning will give you the ability to take advantage of near-existing opportunities more appropriately.
Looking Ahead
As the interest rate environment begins to change once again, this time moving in a more promising direction, business owners will need to adjust their forward-looking approach to ensure that they are on track to take advantage of the rate cut and to benefit from overall improved consumer optimism.
Though the change isn’t overnight, and often sees business owners having to account for various moving parts, this could be a way for them to take stock of their finances, and evaluate how they can make improvements that will help them raise their margins, while still being profitable.
Looking forward, business owners will need to create a more tailored approach that takes their business needs into account. Lower interest rates might not mean that one should be taking on more debt, but instead, use this as an opportunity to consider in which direction your business should be growing.
