Rock-bottom interest rates have been great news for many business owners. But the days of super-low rates may be drawing to a close. Ultimately, interest rates most likely will only go in one direction from here — up.
Unfortunately, rising rates set into motion an entire set of complexities for business owners. For example, companies with variable rate debt may find themselves exposed to increases in the cost of debt service. In the bigger view, rising interest rates have an effect on the overall business environment. For instance, construction firms may take a hit as the cost of financing a project increases and investors scale back.
With a change in the interest rate cycle looming, savvy companies are taking steps now to prepare. Here's how:
Identify and evaluate risks in detail. A proper response to interest rate risk can only come after a full understanding of the risk in context of the firm and its overall strategy. Here, tools such as sensitivity analysis and value at risk (VaR) analysis can help evaluate your company's exposure.
Create a response to each risk. Take steps to better manage working capital, including renegotiating loan terms and/or fixing interest rates. If finances allow, consider paying down debt or, alternatively, budgeting for a significant increase in debt repayments.
Budget accordingly. Budget for debt as a fixed expense, just as you would for payroll, rent and utilities. Experts recommend keeping debt payments under 30 percent of anticipated income (obviously, debt-to-profit ratios may be slightly different for a business during its start-up phase). Next, evaluate your budget at the end of each month to verify that total debt payments were on target. Also, look ahead to see how anticipated debt payments next month compare with anticipated profit. And, when projecting income, make modest projections . While your financial goals (those you share with your sales team, employees and investors) can certainly be aggressive, set the projections slightly lower when budgeting your working capital to account for unforeseen problems.
Secure working capital loans. If you haven't already, source a business line of credit so that you have financing in place to help you weather any storms caused by rising rates. Just be sure to budget for these payments along with your other debts.
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