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What Are the Effects of Interest Rates on Your Business?

written by: •edited by: Donna Cosmato•updated: 7/28/2011

Whether you have an automobile lease, purchase equipment for a company or use credit for any personal or business purposes, it means you owe someone else money. Understanding how interest rates affect you and your business may help avoid a potential financial calamity.

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    Physical Property Changes

    cash or charge 

    Some of the things that get overlooked during times of economic problems are the challenges that individuals and business owners face when interest rates may be increasing. There are a number of direct expenses that are impacted by even a minor change. Some of these include:

    Property loans - Many business owners own their property - or more likely it is owned by a bank or other investor - so these loans may be subject to severe increases with rate fluctuations. During challenging economic times, most business owners are searching for ways of saving money; any increase can result in lower investments in the business including expanding or improving properties.

    Large ticket items - Companies that depend on any type of large ticket items including vehicles for fleet use or equipment (purchased or leased) may find their buying power severely limited. Equipment may be something as simple as copying machines or something as elaborate as a new machine to increase production.

    Regardless of the type of investment that a business is considering, they may be faced with fewer financing options due to decreased buying power. This can often lead to downsizing, layoffs and in more severe cases, ending business operations.

    It is also important to understand that these large assets lose value over time. Increased payments that are unaffordable may not be easy to refinance with a lower rate loan. The more value that is lost, the less likely a business owner will be able to find a loan under more affordable terms.

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    Receivables Decreasing

    The cycle that begins when interest rates are increased is one that is challenging to break. More people may consider saving money and therefore, not spending as much. This results in business owners losing potential customers as they tighten their belts or it may result in longer payment times. Slower payments, increased expenses and other uncertainties cause numerous business problems.

    From a business standpoint, any threat of an increase may cause a cycle in business that can be very damaging. Business owners who are using accounts receivable financing may find their receivables are coming in slower. This is because other businesses and individuals who do business with them may be facing more constraints on their financing. The slower the business receivables are coming in, the more it will cost a business owner in finance charges. The slower the revenues, the less likely a business owner is to invest in new technology, add jobs or increase their marketing efforts.

    As revenues slow and expenses increase, business owners may be forced to make deeper cuts in areas of their business. These deeper cuts may result in serious loss of productivity and revenues.

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    Credit Restrictions

    Credit restrictions Nearly all business owners depend on some type of credit to help them keep their business functioning between receivables. These credit extensions may come in a number of forms. Some of the typical credit that is used by a business includes inventory purchases, salary payments and equipment financing. Each of these categories has sub-categories, all of which may impact a business over a long period of time.

    Inventory purchases - Regardless of what type of business is being operated, there are some basic inventory needs. These needs vary depending on the type of business and the costs vary as well. Larger companies typically operate with a larger inventory and while they may feel the credit squeeze less than a smaller company, it is still problematic. If credit restrictions occur at a time when the business needs to replenish their inventory, there will be few options available.

    Salary payments - Because many business owners depend on lines of credit that help them meet their payroll, restrictions on credit can hamper their ability to make these payments in a timely manner. Any type of restrictions on a credit line can result in a company needing to lay off employees, and this can result in lower production and reduced sales.

    Equipment financing - One of the most crucial issues that a business may have to contend with if they are facing higher rates is a spike in equipment financing costs. These costs can quickly spiral out of control. Many companies lease their equipment and unfortunately, if credit restrictions begin hampering their ability to upgrade equipment or purchase new equipment, this can have a negative impact on the company's bottom line.

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    Small Change Can Mean Significant Damage

    Small business owners are less likely to feel the credit pinch or a rise in interest rates than their larger counterparts. The larger the company, the more likely they are dependent on credit for their business. Business owners of all sizes should carefully review any credit contracts they have regardless of the size. This includes business credit cards, lines of credit for inventory and loans that are being used to finance equipment, property or any other aspect of their business. Being aware of the potential risks associated with the need to pay a higher interest rate and planning in advance for these potential increases can help cushion the blow and minimize the amount of damage that a business may need to deal with.

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    Resources

    Sources:

    Investopedia

    1. Stammers, Robert, CFA, "How interest rates affect property values," Investopedia, http://www.investopedia.com/articles/mortgages-real-estate/08/interest-rates-affect-property-values.asp#axzz1TL2aqbm8
    2. Worrell, David, "Small Business: Speed Up Receivables To Avoid A Cash Crunch," Investopedia, http://www.investopedia.com/articles/fundamental-analysis/08/factor-receivables.asp#axzz1TL2aqbm8

    Business Week: Bloomberg Small Business Reports

    1. Small Business Rate Report http://www.businessweek.com/smallbiz/resources/rate_report/sb_rate_report.htm

    Image credits

    • Gold Credit Card contributor Michelle Meiklejohn via freedigitalphotos.net
    • Cash - Loan contributor Renjith Krishnan via freedigitalphotos.net