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What Do Rising Interest Rates Mean for Small Business?

“Interest rates are rising.” That has been the steady drumbeat resounding in business and financial media for several years now. But if you’re a small business owner, how much should you care every time you see this headline pop up? Is it good? Is it bad? Somewhere in between?


The truth is, rising interest rates have a complicated effect on small businesses in general. So, every time the Federal Reserve raises its benchmark interest rate, there’s actually a little pushing and pulling going on. Rising rates also will be more beneficial or detrimental based on things such as your industry and where you are in the growth cycle.

Here’s what small business owners need to know about the current environment of rising interest rates.

First Up: What You Need to Know About Interest Rates

The Federal Reserve, America’s central bank, has the power to increase or decrease something called the “federal funds rate.” This benchmark short-term interest rate has an effect on things ranging from how much you pay in interest on your credit card, to how much banks charge for mortgages, to how much interest is paid on U.S. Treasury bonds.

The Federal Reserve won’t necessarily dictate exactly what rate you’ll pay on a loan, but in general, rates tend to rise and fall alongside the fed funds rate.

So why does the Fed move the benchmark rate? To manage the economy. For instance, the Federal Reserve dropped interest rates to virtually zero in late 2008 in response to the Great Recession. You see, lowering interest rates is a way to spark a weak economy – it lowers the cost of borrowing, which makes things such as taking out a small-business loan or entering a mortgage to buy a house more enticing. However, an overheated economy can actually create high levels of inflation (in which the dollar buys less over time). The Fed can combat this by raising interest rates, thereby making it more expensive to borrow, in turn helping cool off the economy.

Historically, there’s hardly a “normal” rate – the federal funds “effective” rate has spent varying amounts of time from anywhere between virtually 0% and roughly 19% over the past few decades. More recently, the Fed funds rate was kept near zero between 2008 until late 2015 to help the economy recover; the central bank has since raised rates several times to their current 1.75%.

What This Means for Small Businesses

The Federal Reserve typically raises interest rates when it believes the economy is or will be in danger of overheating. So as a general rule, you can view interest-rate increases as a good signal that the U.S. economy is humming along pretty well – and that’s good news for you, broadly speaking. It’s a vague indication that more people are employed and wages are decent, which means there are more people that are capable of buying your goods and services.

That’s the good news.

The bad news is, rising interest rates can have a direct, negative effect on your small business’ budget.

When the Fed hikes its benchmark rate, that typically will send the “prime” rate (what banks typically charge its best customers – often a couple points higher than the fed funds rate) higher. That certainly will affect anyone who’s looking to take out a new small business loan to, say, purchase equipment or fund a significant upgrade in office technology. But it also can hit you if already taken out a so-called variable-rate loan, where your interest payments change as market rates change. It can even hit you in smaller ways, such as higher interest charged for your business credit card that you use for small expenses.

There is one small positive offset, however. Higher rates make lending more lucrative for banks, prompting more financial institutions to jump into the fray. That increased competition can help bring the actual commercial rates back down as banks battle for your business.

Even small changes in interest rates can make a big impact on a small business’ budget, literally becoming the difference between profitability and losses. That means if you haven’t been paying much attention to the Fed’s actions of the past few years – or if you’re not aware that the Fed is expected to keep hiking interest rates in 2018 – now is the time to figure out exactly how it may affect things such as your expansion plans and your bottom line. Not sure how? The accounting experts at McManamon & Co. can help you do just that, determining what any change in interest rates will have on your business, now and in the future.

Rising interest rates can chew away at your profits and potentially disrupt your growth – if you’re not prepared. Make a plan today by reaching out to us online or call us at 440.892.9088.

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