Finding a chair when the interest rate music stops: it pays to be prepared.
March 19, 2019
As interest rates rise off historic lows, clients are asking what, if anything, they should be doing differently. The Federal Open Market Committee raised the fed funds rate by a full percentage point in 2018 and expectations are for another half point raise during 2019. Inflation and interest rates typically move in sync. Does that mean we should expect inflation to increase? Lower than normal interest rates and lower than normal unemployment certainly point to higher future inflation While there are plenty of forecasts, nobody really knows what will happen in the future. But, we do know the implications of higher interest rates and higher inflation.
For example, if the interest rate on your loan goes from 2.5% to 3.5%, then the interest paid on the same amount of debt will go up by 40%. If inflation drives up the costs in a business, profit goes down without offsetting price or productivity increases. If the cost to borrow goes up or profit goes down, then the borrowing capacity of a business decreases. When both happen at the same time, liquidity can dry up very fast.
If interest rates and inflation are increasing, it creates problems for companies that fail to adjust in time and creates opportunities for companies that do. The last time the Fed steadily raised interest rates was 2005, and we all know how that ended. Most of us who were running businesses at the time recall that there were opportunities. But to take advantage, your business needed to be prepared.
In general, getting ready for rising inflation and rising interest rate is about managing three fundamental areas of the business: customer pricing, cost structure, and asset utilization. Managing these three areas properly creates the flexibility and liquidity to capitalize on the opportunities. Interest rates may continue to rise, and inflation may increase — or they may not. In either case, preparing will merely make your business more efficient and generate more cash. In our next post we will discuss how to manage these three fundamental areas of your business. Contact Exceptional Leaders International to learn how we can help.