Rising interest rates are a frequent topic in the news. While much of the hand-wringing about spiraling rates has to do with the housing sector, businesses of all kinds are affected by the increases. As interest rates rise, the cost of borrowing also increases, which leads to lower profits and, ultimately, a slowdown in demand for products and services of all types.
Surging interest rates, however, also signal an opportune time to revisit your balance sheet. Companies that pro-actively adjust their accounts-receivable policies, reassess their cash-flow projections and explore alternative investment strategies will find themselves ahead of the curve when it comes to planning for the long-term.
“This is a good time to revisit your assumptions,” says Pete Gautreau, partner at accounting firm Vicenti, Lloyd & Stutzman LLP.
Smart Business spoke with Gautreau about the effect that rising interest rates will have on the business environment, the importance of paying down revolving debt and why he wouldn’t postpone earmarking funds for necessary capital improvements.
How do rising interest rates affect business operations?
They create uncertainty and leave a big unknown in the long-term planning process. As the cost of money goes up, it becomes more important to weigh financing options, explore cash management opportunities and communicate well with existing and potential lenders.
Higher interest rates tend to correlate with delayed payments from customers. How should accounts receivable be monitored during a period of interest rate hikes?
Early payment discounts offered to customers can be tailored to those that you want to encourage a prompt remittance. However, you don’t want to go overboard by offering discounts just to hasten payment. The cost of offering discounts can easily outweigh the increased cost of money that occurs when interest rates rise. Also, it is important to make late payment penalties explicit in customer arrangements and have them strictly enforced. Finally, a manager should be personally responsible for collections in a company.
Why is it important to speed up cash flow to pay down revolving debt?
When interest rates go up, the gap between savings rates and borrowing rates widen. This makes it increasingly important to use excess cash to pay down revolving debt. Most companies now make use of automated sweep accounts with their banks, which is an automated device that takes excess cash out of a company’s bank account and uses it to pay down debt. This occurs constantly without much effort. Most banks now offer this service, but not many bankers necessarily volunteer the information that it is available.
Is this a good juncture to re-evaluate cash flow projections?
Debt service, assumptions on rates of return, discounts — all these assumptions should be revisited in a flex market such as this. It’s also a good time to negotiate with customers, vendors and lenders. Having a solid understanding of your company’s current and future cash flow will serve as a great basis for those discussions.
With interest rates escalating, how should excess cash be invested to achieve optimal levels of return?
Paying down revolving debt becomes increasingly important. If a company is debt-free and liquidity is not an issue, then getting money out of a noninterest-bearing account and into a CD account or flexible interest-bearing account would be a good move. Also, if the liquidity is there, fixed-income securities make sense as the yields are increasing. Taxfree bonds are also an option as they are paying excellent rates with no taxes dues on the earnings.
How long should the investments be tied up for?
I would recommend that investment maturities be staged. Many times, your primary bank has the ability to wire money into CDs from other banks. This is done to keep the credit concentration risk down, find the best rates, and to stage maturity dates. Not many businesses have the luxury of investing in fixed-income securities as those normally require a longer lock in period. It’s unusual for a business to lock things in for more than six months.
What advice would you give to a CEO or business owner about making capital improvements in the current environment?
I believe industry and general economic trends should weigh more heavily in a decision such as that. Where the interest rates are going to go, where the market is going to go, is really anybody’s guess. Capital improvements are a long-term commitment for a long-term payback.
We’re in a volatile market now. If I were to be making these decisions as an owner, I would see the current market conditions as a short-term phenomena. I don’t know if I would weigh that too heavily on my capital improvements, which are long-term investments.
PETE GAUTREAU is a partner at accounting firm Vicenti, Lloyd & Stutzman LLP. Reach Gautreau at (626) 857-7300 or [email protected].