Here’s how small business owners can manage their finances as interest rates go up
(This article originally appeared in the Philadelphia Inquirer)
Two weeks ago the Federal Reserve announced a 75-basis point increase in a key interest rate:its Federal Funds rate, which banks charge each other to borrow or lend excess reserves overnight. Fluctuations in this rate affect interest rates across the banking system. So it’s no surprise that, since the announcement, rates for both consumers and businesses have increased.
For example, a 30-year fixed rate mortgage now averages 5.81%, compared to 3% a year ago, and the prime rate — which is the interest the bank charges to its best customers — charged by financial institutions like Bank of America is now at 4.75% compared to 3.50% as recently as March.
Obviously, interest rates are rising, and many economists think rates will continue to go up as the Fed battles both inflation and a slowing economy. For a small business like mine, all of this means higher costs to maintain debt and borrow additional funds. It may also potentially result in less capital available. So what can we do now to prepare?
For starters, small business owners should be making sure that we’re paying down our credit card debt and any other higher interest loans with variable rates. The interest on this debt could become very costly. If you’re able to pay down these higher rate loans then do it. If not, then try and convert this debt — or portions of it — to longer-term loans with fixed interest rates, even if it means pledging collateral to secure these loans.
“Rising debt service costs can be a material, and unexpected, hit to cash flow and preparing for that early is crucial,” says Clifford P. Haugen, a financial advisor with BLB&B Advisors, LLC in Montgomeryville. “If a small business owner hasn’t looked at the terms of his or her loans recently, now is a good time to do that.”
If you need financing, you’ll find the best rates (and the best chance of approval) with either the government-backed Section 7(a) and 504 loans offered by lenders approved by the U.S. Small Business Administration. Or, ifyou’re a Philadelphia-based company, check with the Philadelphia Industrial Development Corporation. Also try to take advantage of the State Small Business Credit Initiative, where — thanks to the 2021 American Rescue Plan Act — more than half a billion dollars is being made available over the coming months to businesses in Pennsylvania, New Jersey and Delaware by the federal government through local lenders and community organizations.
Interest rate increases will drive up your cost of borrowing. But there is a silver lining: the potential to increase your income if you manage your money wisely. Savings account rates aren’t significantly rising just yet, but they will. Talk to your banker and set up higher yield checking or money market accounts and start sweeping any excess cash there.
Consider putting any cash you don’t need for six months or a year into FDIC-insured certificates of deposit, which generally pay higher interest but lock up your funds for a period of time. Also consider U.S. Treasury bills in the short term until interest rates start rising.
“The 3-month U.S. Treasury ended the week at 3.35% — levels we haven’t seen in nearly 15 years,” says Haugen. “With inflation well above those levels, those are still negative real returns. However, with banks and money market funds paying, effectively, 0%, the ability to buy a short-term Treasury ladder and hold the bonds to maturity is looking pretty attractive.”
If you’re willing to take a little more risk and can invest for the long term, then consider moving excess cash to mutual funds which invest in blue chip, dividend-paying equities, which have historically proven to outpace interest earnings.
“I am advising my clients to rebalance their accounts,” says Steven Kalodner a wealth advisor and portfolio manager at financial services firm UBS in Mt. Laurel, N.J. “This may often involve buying some blue chip dividend yielding companies.” Kalodner cautions, however, that the stockmarket may reach “new lows this year” and investors ought to be “slow to purchase many stocks except the best of the best.”
While we’re on the topic of cash, we should all be doing our best to manage it better.
That means stepping up our credit and collection activities to ensure that any open receivables we have aren’t outstanding more than 30 days or even less if possible. The longer our invoices stay open, the less interest we’rereceiving on our money. I’m advising my clients to try and take advantage of any supplier discounts for early payment, as oftentimes these discounts may earn more than the interest a bank is paying.
The most important thing, in these times of higher interest and inflation, is to work with someone experienced in financial markets because, as Kalodner believes, no one investment is right for everyone: We’re all at different stages in both our professional and personal lives.
“Today’s markets are very volatile and interest rates are the highest they’ve been in several years,” he says. “I strongly suggest business owners talk to their financial advisors and come up with a plan if they don’t have one, which would address what investments they should own.”