How should small businesses react to interest rate rises?

On 22nd June the Bank of England raised the Base Rate to 5% with further raises expected throughout 2023 and some analysts predicting rates could reach 6% by the end of the year.

According to Paul Dales Chief UK Economist at Capital Economics, in order to control inflation, the Bank of England may need to hold rates as high as 5.25% until the second half of 2024.

So, before lenders reconsider their rates, if your business could do with a cashflow boost or you plan to make any significant purchases over the next 12 months. Secure your funding before rates rise again.

Why are interest rates rising? 

The Bank of England continues to raise interest rates in a bid to control price rises, the inflation fuelling the UK’s cost of living crisis. Inflation is the measure of how much higher prices are than last year. High inflation means goods and services are much more expensive than last year. The result is everyone bears higher costs, many staff demand higher wages, costs go up again, so prices go up again.

The UK’s inflation stems from increased demand for goods and services out-stripping supply post-pandemic, and reduced supply of certain products following among many things the war in Ukraine.

Raising interest rates makes financial commitments from mortgages down to your phone contract, more expensive. This means consumers have less disposable income, so they reduce discretionary spending on less critical items. Demand falls, meaning the price of goods have to come down otherwise they won’t be sold, but this is where businesses start to get hurt.

How do interest rate rises affect small businesses and what can they do about it?

Whilst the effect of rate rises on mortgages and homeowners is well-known, the impact on small businesses is less widely reported, but our customers experience a raft of consequences when rates rise:

Reduced Consumer Spending

When customers tighten their belts, certain sectors feel it first. Hospitality feels the pinch as consumers spend less on eating and drinking out. They also hold back on major purchases which means anyone involved in the supply chain sees a slowdown. However, some industries are less affected than others, with the beauty sector for example notoriously resistant to changes in the economy.

What to do?

Consider whether your business can adapt to serve customers less affected by the economy, or appeal to new segments where demand still exists. Do you offer something that others do not? Boost your marketing efforts to make sure you capture the demand that does exist.

Less Demand But Fixed Costs

Many businesses are tied-in to service contracts that may be beneficially low right now or, like energy costs, may be difficult and high.

What to do?

Whenever a contract comes up, hunt around for the best deals and negotiate as hard as you can. Can you work smarter, be more productive or save costs by being energy efficient? If energy prices don’t fall far, and high is the new normal, energy saving initiatives and green energy sources will pay back over a shorter time. Cast a critical eye over your energy usage and explore whether technology can improve your efficiency. Can you generate additional income from what you have? Can you sub-let office space, diversify your land usage, add B&B rooms to your pub, cater events from your restaurant, manufacture a broader range of products or run delivery for different customers? Evaluate every opportunity you can think of to see if you have cost-effective options to increase your income streams.

Higher supply-chain costs

From animal feed to timber, food ingredients to fuel, almost every component or ingredient is increasing in price.

What to do?

A tricky issue because switching to cheaper ingredients or components often means lower quality which means a worse product and likely less customers. Try to buy in bulk to negotiate better deals, consider contacting other businesses that might use the same materials and order together to increase your buying power.

Late payments from customers

If you sell to other businesses, when they start to struggle, an early sign is late payment. In turn this means your own cashflow is restricted, you might not have the capital to place further orders for materials or you can’t pay other suppliers on time, causing not only a spiral but a negative effect on your credit rating.

What to do?

Keep in close contact with all your customers so you are at least on top of any issue and can see it coming. Communication and the strength of relationship with your customer are key, because if a legal situation was to occur you may be well-down the pecking order. Payment plans or staged payments make sense if any issues are temporary but being over-accommodating can mean you miss out on vital cashflow. Don’t over commit yourself to forward orders if you think this is a risk.

Can you get your customers to pay in advance? Some Businesses that actually do well from interest rate increases are those with what’s called negative working capital. If a customer pays in advance for something, such as a holiday, that money then sits with the provider until a much later date and has the opportunity to earn interest or be invested elsewhere. Over time off-setting some of the negative effects of rate rises.

Restricted access to funding and more expensive finance

Business to business lending rates are quite varied, affected by the trading situation and trend of the business, assets held, cash at bank, payment reliability etc as well as the credit history of the directors themselves and perhaps other businesses they own. Whilst changes in the base-rate do affect the lowest available rates, it’s more likely that lending criteria tightens and so your business finds it more difficult to get accepted for finance. Facilities with variable interest rates are ones to look out for. Credit cards and overdrafts for example may be able to increase their rates quickly with little warning to yourself.

What to do?

At Portman we would always recommend seeking professional financial advice. Make sure you are up-to-speed with tax allowances, full-expensing for example currently allows you to write-off the full value of a qualifying purchase in year 1. When seeking finance, we naturally suggest talking to ourselves. As both a broker and lender we can lend our own funds or can select from our panel an appropriate lender whose criteria best matches your situation. Most of our lenders are specialist and not available on the high street, with many working not working directly with business owners at all. Once we get an understanding of your business and goals, we will search the market through our panel and find the best available option.

British Business Bank suggests choosing fixed-rate or flexi-loan options

Whilst it may seem counter-intuitive, if your business needs finance, The British Business Bank suggests businesses explore fixed-rate, flexible and alternative funding options.

  • Locked-in rates over a number of years offer certainty and protection against future rises.
  • Funding from lenders with flexible criteria provide access to funds not available from traditional banks.
  • Flexi-loans also allow a loan to be paid off as soon as you like, in order to reduce interest payments.

So how should your business react to interest rate rises?

Definitely don’t do nothing. Review your business plan and work out what to do in different scenarios. Make sure you know your balance sheet, where your most profitable income comes from and where your risks are. Control costs, look for efficiencies then try to boost your brand presence. Pick up new or different customers, or diversify activities to broaden your income streams.

In the end you may need to adjust your prices, passing some of the increases on and the sooner you get customers used to it, perhaps the better.

To explore your funding options, talk to Portman. We can discuss fixed-rate agreements that give you budgeting certainty, or flexi-loans that allow you to reduce the amount of interest you pay by settling early with no fees.