With Rising Interest Rates, it’s a Good Time to Re-Evaluate Your Working Capital Position

In an attempt to fight near-record inflation, the Federal Reserve raised interest rates a quarter of a percentage point in March. Less than two months later, they raised rates once again – this time by a half of a percentage point, the largest such hike in 22 years.

Data from the U.S. Department of Commerce in late April showed prices had surged 6.6 percent during the 12 months ending in March. That number is the sharpest increase in prices since 1982. Strong demand across all sectors is still outpacing production due to ongoing supply chain and staffing woes.

The Fed is hoping that making borrowing more expensive will lessen demand and restore some economic equilibrium disrupted by the pandemic and the stimulus programs implemented in response. According to a March report from the Fed, the latest interest-rate increases might not be the last for 2022. Analysts from the Economist Intelligence Unit expect the Fed to raise rates seven times in 2022, reaching 2.9 percent by early 2023. including a potential three-quarter of a percentage point increase in June – an increase not seen since 1994.

What Do Increased Rates Mean?

For consumers, rising interest rates make it more expensive to take out a car loan or carry a balance on a credit card. Mortgage rates have already soared above 5 percent, up from less than 3 percent a year ago.

Same goes for businesses: borrowing money is becoming more expensive for both operating lines and term loans. Many lines of credit are repriced monthly, so higher interest rates hit the company almost immediately. Higher interest rates raise businesses’ cost of capital and negatively impact cash flow. Even if the company doesn’t have debt, upstream and downstream debt (supplier and customers) will have an impact on liquidity. The impacts will be felt across the supply chain, but could be particularly devastating to smaller suppliers that will have less access to capital from traditional lenders. The risk of bankruptcy is likely to rise at all tiers within the supply chain but especially lower-tier suppliers.

The trickle-down effect of less capital for suppliers results in increased costs of goods and potential supply chain disruptions as suppliers have to scale back production or inventory simply because they don’t have the cash flow to maintain operations.

Weathering the Rate Hikes

With interest rates rising – and more hikes on the horizon – the question becomes, what can businesses do to protect themselves and their supply chains?

While all businesses are unique, generally speaking, accounts receivable and accounts payable finance programs provide great options to companies of all sizes to improve their working capital position in the face of more expensive money. By using solutions that leverage technology, buyers and suppliers can start seeing an impact almost immediately.

Couple higher rates with banks’ general tendency to be risk averse and businesses can greatly benefit from looking at non-traditional funding sources – especially supply chain (or accounts payable) finance (SCF) programs for mid-to-large enterprises. SCF reduces the cost of capital for mid-market and small suppliers, mitigating higher interest rates, and supporting supply chain health. By offering early payments, an SCF program can improve the relationships with suppliers and lessen the likelihood of a price increase. SCF also allows buyers to optimize their cash flow with payment terms, freeing up working capital for the buyer.

Maintaining Credit Discipline

In any interest rate environment, managing and mitigating risk is important for business success. As money gets more expensive, maintaining discipline around counterparty risk is critical to avoid disruption to a company’s operations. Simply put, higher interest rates drive tighter liquidity and high risk of defaults. With that in mind, now is a good time to re-evaluate – and heighten monitoring of the credit worthiness of your customers, supplier concentrations, and the overall health of the supply chain.

Summary

While we can’t know the exact effects of the Federal Reserve’s actions – or impending actions – it’s clear that rising interest rates can have major micro- and macroeconomic impacts. And while every business and industry is unique, maintaining cash flow is vital to success. But to do so in the current environment, it may be necessary to do things differently than have been done in the past (both in the short and long term) and reassess where their vulnerabilities may lie.