The Impact of Rising Interest Rates on Small Businesses
Interest rates in Canada are on the rise to help contain inflation. The Bank of Canada increased the benchmark rate on April 13th by 0.5 percentage points to 1.0. This is the biggest one time increase in borrowing costs since 2000. While a higher rate environment may be effective for inflation, it can have significant consequences for small businesses.
Loans become more expensive and difficult to secure
According to the Canadian Federation of Independent Business, debt repayment has become one of the biggest challenges for small businesses during the pandemic. Short on cash, many small businesses were forced to borrow to sustain their operations during this difficult period.
Given debt repayment is a critical challenge, higher interest rates will only increase the burden. As rates rise, lenders increase the prime rate and it becomes more expensive to borrow. Credit cards, lines of credit, and both short and long term debt now carry a higher cost. Loans become not only more expensive but also take longer to repay.
The situation will be exacerbated considering the Bank of Canada is falling farther and farther behind curve. Jean-Francois Perrault, chief economist of Scotiabank stated “we now predict that the Bank of Canada will raise its policy rate by an additional 2 percentage points this year, ending the year at 2.5%”. The cost of borrowing could become the deciding factor for the survivability of small businesses.
In addition to loans being more expensive, they may also become more difficult to secure. Banks will increase their scrutiny for new loan applications due to a higher risk of default. “Small businesses face considerable barriers based on their size when they apply for bank financing” according to Dan Kelly, President of the Canadian Federation of Independent Business.
Expansion will be put on hold
Company growth can be hindered in several ways as interest rates rise. “Fifty five percent of companies said a one percentage increase in the prime lending rate would put material, substantial or considerable pressure on their business and cash flow”.
Cash flow is the lifeblood of a business. With limited cash flow due to a higher cost of capital, small businesses will decrease their capital investments and shelve expansion plans. As expansion plans slow, hiring will most likely be placed on hold as the business works on managing their core operations.
Decreased consumer spending and demand
Over half of Canadians are concerned about the impact of rising interest rates. Rising interest rates are intended to curb inflation by tempering demand. The rate in turn affects consumer habits. Typically, when interest rates rise, consumers save more and spend less.
When consumers pay higher interest on personal loans, they have less disposable income to buy goods and services. Higher rates cause consumers to focus on bills they must pay, such as housing, car loans and food. This leaves less money for spending on travel, restaurants and entertainment. As consumers struggle to cope with higher rates, small businesses will begin to feel the effect of less demand for their products and services.
What can small businesses do to reduce the impact of rising interest rates?
- Review and revise your business plan to make sure that it is up to date for an environment with higher rates. Are all your products and services profitable? Adjust your business plan to focus on high-margin goods and services.
- Evaluate the risks associated with your type of business.
- Plan for the future. What will you do if rates continue to rise?
- With interest rates expected to rise through the end of 2022, you may wish to secure a fixed rate versus a variable loan.
- Evaluate your debts and outstanding loans. Are there ways to reduce the amount that you owe?
- Do you think you can raise your prices to generate more cash to offset higher interest rates?
- Review your lease. Can your employees work 2 or 3 days a week at home, allowing you to reduce your office space?