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We look at how larger companies could be impacted if interest rates rise as expected.
Last updated: 18 Oct 2021 6 min read
UK interest rates could increase from their record low of 0.1% amid rising inflation and energy prices. Investors are expecting rates to be raised later this year or early in 2022.
Rate rises can affect companies in a number of ways, so now is the time to assess how this might impact your business operations.
Businesses should be prepared for every eventuality and aware of the risks of overextension of borrowing in an environment conducive to rising rates. With an increase in interest rates, businesses with company credit cards and existing loans can have higher interest payments, less disposable income and bigger overheads. In some cases the business may end up paying off the interest only, rather than the loan itself.
Rob Kelly, finance director at Marriott & Kelly Accountancy, says: “A company that doesn’t pay off its debts could be less appealing to investors. It may also prevent them from being able to apply for another business loan, which creates a snowball effect of potential issues and problems for the business.”
Increased interest rates could also mean businesses opting for shorter-term loans tied to cash flow and presenting greater risks, potentially leading to further negative impacts.
Higher interest rates can increase the value of currency. If businesses have income streams in foreign currencies, then rising interest rates, and in turn rising sterling, will affect a company’s profits.
Since November 2017 and the Bank of England’s first rate hike in a decade, the pound has rallied 7% against the dollar, with the expectation of further hikes to follow supporting this upward momentum.
“Any business with material revenues in foreign currencies will have to consider the impact of rising rates and a stronger pound,” says Phil McHugh, chief market analyst at Currencies Direct. “If a business is sitting on reserves in a different currency, again a stronger pound will impact the business should it wish to convert these reserves back to sterling.”
Forward contracts can be used to mitigate the risk of exchange-rate differences where your business has foreign currency transactions.
Short-term bank credit is directly attached to cash flow, and cash can come into a business at different rates and different times according to the business cycle. And short-term bank credit and short-term loans are paid through cash-flow activities on a month-by-month basis. Operating a business on short-term bank credit is a risk; if interest rates increase, so do loan repayments, leaving companies repaying more than they had originally planned for. A company that operates on short-term bank credit needs to be confident of a steady cash flow and a buffer if necessary in case of any unforeseen issues.
“For more successful business owners, interest rates provide an opportunity to grab better talent, assets and market share”Rob Kelly, finance director, Marriott & Kelly Accountancy
An immediate profit impact will be seen by those companies reliant on short-term bank funding. However, converting an overdraft facility into a long-term loan could reduce interest charges but put more scrutiny on cash-flow planning.
Karen Borowski, director at accountancy firm Revell Ward, says: “How the business manages that exposure will vary depending on their attitude to risk and the degree of exposure. But there are ways to manage that risk – for example, by looking at interest rate fixing or hedging, which help bring some certainty to the situation.”
The internal rate of return (IRR), a standard measure of capital investment value, compares returns with costs. Inevitably, rising interest rates can affect those costs and reduce the IRR.
Interest rate increases can be a positive asset to business cash-flow management, encouraging business owners to save more. However, they still need to be cautious. “For more successful business owners, interest rates provide an opportunity to grab better talent, assets and market share,” says Rob Kelly. “And innovation seems to improve when interest rates are at their highest, as businesses are forced to do more with less, and within tighter budgets so businesses can emerge stronger and therefore more appealing to investors.”
Of considerably greater concern is corporate business’s continued reliance on the IRR as a basis for determining which projects receive funding in the first place.
Andrew Duguay, senior economist at analytics company Prevedere, doesn’t believe that a rising-interest-rate environment will necessarily mean less investment and innovation. “It just means the threshold for return on investment is higher,” he says. “In the historical context, for the past hundred years, businesses have had to deal with much higher rates than those that we will be experiencing in the next five years, and many firms have thrived in a higher-rate environment.”
Companies need to be conscious of the fact that while they might be relatively insulated from interest rate rises, their key partners, ie their customers and their suppliers, might not. Even if your company has no funding affected by interest rate changes, your suppliers may do, and your prices may increase as they cover increased interest charges. Having contracts in place to fix supply prices can mitigate this risk.
Nevertheless, interest rate increases force companies’ hands, with inflation driving up the pricing of manufacturing, distribution, taxes, and business services, which then trickles down the business supply chain.
Rob Kelly says: “Overheads such as office and workspace supplies, materials and utilities will increase – so it would be bad for companies paying more to run their business and make their products, or deliver their services, but not increasing the cost of what they were selling. This can be both beneficial and risky, as businesses can lose customers and clients, but there is always an increase in demand, which could drive new and better-quality business through.”
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