Four Ways to Protect Your Company’s Finances From the New Fed Rates
by Scott K. Schmidt, Chief Financial Officer, U.S. Money Reserve
Inflation is on the rise, and the Federal Reserve has begun to battle it by increasing interest rates. While you may think that interest rates only affect consumers, these rates also affect businesses. Over the last two years, thanks in large part to the pandemic, firms and consumers have enjoyed historically low interest rates, making everything from homes to automobiles more affordable. That sent the American public on a buying spree, which was then hampered by the supply shortage thanks to the global pandemic. In turn, inflation has slowly crept up, and the Fed has had to raise interest rates to battle it. Here are four ways you can protect your company’s finances from the new Fed rates, plus information on important factors you need to understand about inflation and interest rates.
What Is Inflation?
We often hear about inflation, but it’s not necessarily an easy concept to understand. At a basic level, inflation is a continued increase in the price of goods and services over a period of time in an economy.
While there are many reasons for prices to increase, inflation impacts both consumers and businesses because it takes more money to buy the same goods or services. Consumers and businesses can’t make a dollar go as far as it did in the past. That means firms and consumers have less purchasing power than they did previously.
The Federal Reserve keeps a close watch on inflation (and its opposite, called deflation) because it is an indicator of the economy’s strength. For example, if a gallon of milk previously cost $3 in 2019 but costs $5 in 2022, this could be an example of inflation — but it’s actually a bit more complex than that. A rise in the price of just one good doesn’t indicate inflation.
The Consumer Price Index, or CPI, is a key measurement of inflation. The CPI measures the change in the prices of a selected “basket of goods” of more than 94,000 items that have been scientifically selected to represent what consumers spend their cash on. In July, the Fed raised rates by 75 basis points, to a target range of 2.25 to 2.50%, to curb inflation. In its announcement at that time, the Fed said it didn’t expect to have to further raise rates as the year advanced in order to continue to curb inflation. However, members of the Fed have publicly said that we should expect rates to climb to around 3.9% by the end of the year.
Why Does the Fed Increase Interest Rates to Fight Inflation?
The Federal Reserve, or Fed, operates under a few key goals, including maximizing employment, maintaining moderate long-term interest rates, and keeping prices stable. These goals help keep the economy healthy. The Fed doesn’t like to make quick moves, and in general, it uses things like interest rates to help keep the annual inflation rate at around 2%.
The Fed sets interest rates in a slightly convoluted way, so bear with me. It sets the rates for commercial banks for short-term borrowing. Commercial banks (say, Bank of America or Chase) then pass those rates along (with their own adjustments) to consumers for everything from credit card rates to interest rates on loans. When the rates go up, borrowing money gets more expensive for consumers and businesses; when they go down, borrowing gets more affordable. Higher interest rates slow down the rate at which people can borrow money (because it’s more expensive), which essentially slows the economy down and can reduce inflation.
Is the U.S. Economy Facing Inflation?
This is literally and figuratively the million-dollar question: Is the U.S. facing an inflationary period? If you’ve read any headlines over the last six months, you know that there is a big debate going on about whether or not we’ve got inflation happening in the U.S. economy. Plenty of conversations are also going on about whether or not we’re at something called “peak inflation,” which is when inflation reaches the highest level it has ever reached.
As of August 10, 2022, the inflation rate sat at 8.5%, according to the Bureau of Labor Statistics (BLS) CPI number. This is near a 40-year high. A key driver of that inflation rate has been the rising cost of gas, with the national average hovering just under $4 a gallon as of today. Gas prices are one of the items in the basket of goods that is used to measure inflation. In short, the U.S. is currently in an inflationary period. Still, it’s important to keep in mind that the key numbers the Fed and the BLS use to determine inflation are backward-looking — meaning they take the last month’s data, not the current month’s data, into consideration. That’s why there’s some debate about whether we are at peak inflation.
What Does Inflation Mean for Companies Both Large and Small?
Like consumers, businesses need to purchase goods and components to keep their companies up and running. They also need to hire people to keep the lights on. Inflation affects companies of all sizes because it increases the costs associated with keeping business running. Depending on the type of business, size, and even location, businesses can either be tremendously impacted by inflation or only moderately impacted by it.
According to a survey by Business.org from July of 2022, 92% of small business owners surveyed have seen an increase in their costs since the beginning of the global pandemic. Of those, 26% have seen their costs increase by 20% or more.
In addition to this, borrowing to grow your business, hire new people, or open new business lines has increased in cost. Business owners, just like consumers, are faced with more expensive loans, which in turn impacts the prices they can charge for their goods and services.
To counteract this increase in business costs, many companies and business owners have chosen to cut overhead costs, increase prices, and even lay off employees. Even large businesses like Walmart and Meta (Facebook) that typically boom during inflationary periods have chosen to cut back on staff to control the rising costs.
Four Ways to Protect Your Company’s Finances From Rising Rates and Inflation
With all this negative news, what’s a company to do? You have a few options. Here are four ways to protect your company’s finances from rising interest rates and inflation.
- Do a Financial Health Checkup.
It’s always vital to stay on top of your financial health, but now more than ever, it’s really important to make sure that your business doesn’t have any negative marks on its credit report. Just like people, companies can get into problems if they don’t pay bills on time. Make sure you have strong credit and revenue reports so that you’re more appealing to lenders should you need to borrow money as rates rise.
- Review Your Current Financing Plans Now.
Now is a great time to check in with any and all of your financing plans — whether they include lines of credit, loans, or invoice factoring — and make sure you understand how interest rate increases might impact your monthly payments. If you have any variable-rate loans, make sure to refinance them now and get into fixed-rate products. This will help you manage the costs of the loans as interest rates increase.
- Get New Financing Now.
Since the Fed has publicly said to expect rates to climb close to 4% by the end of the year, now is the time to start lining up any financing you might need for the next six months to a year. If you do apply for financing, make sure that the rates you get are fixed (not adjustable). Adjustable-rate financing may seem like a bargain right now, but it won’t be so affordable if the Fed raises interest rates again.
- Pay Down High-Interest Debt.
Now is the time to pay down any high-interest debt that you and your company may have — that way if interest rates do increase, you won’t be left paying more in interest than in principal. This is particularly relevant if you’re carrying business debt on your credit cards.
The Bottom Line on Protecting Your Company’s Finances From the New Fed Rates
There’s no way to completely insulate your company from the impending Fed rate increases, but there are ways to lessen their impact on your business. It’s vital to understand the ins and outs of inflation and the actions the Fed takes to manage it. It’s also important to take a close look at your financial health, any outstanding loans or lines of credit, and your plans for the future to help reduce the impact that rising interest rates may have on your company. If you follow these tips, you’re sure to be ready to face the impending economic changes and weather them with aplomb.