How Do Interest-Rate Cuts Affect Small Businesses?
If you’ve paid any attention to U.S. financial market news this year, you’re probably well aware that one of 2024’s biggest stories has revolved around the Federal Reserve and its benchmark interest rate.
And now that a change to that interest rate finally seems all but guaranteed, small businesses need to be aware of the variety of ways in which the start of a rate-cutting cycle might affect their company.
Today, we’ll talk to you about what you need to know — some interest-rate basics, how interest-rate cuts would impact small businesses, and why they’re expected to start falling soon.
Why Do Interest Rates Matter?
Interest rates are a key economic lever used by central banks (like the Federal Reserve) to control inflation, stimulate growth and maintain financial stability. When the economy is struggling or in need of a boost, the Federal Reserve might cut interest rates. When it’s running too hot, the Fed might raise them.
Why? Because interest rates represent the cost of borrowing money.
The Fed funds rate itself is a target rate at which commercial banks can lend and borrow extra reserves to each other overnight. This rate itself affects the “prime lending rate” (a higher rate at which banks will lend to their most creditworthy customers), which in turn ends up affecting the rates on commercial loans of all sorts — credit cards, auto loans, mortgages and more.
When central banks cut benchmark interest rates, they’re essentially lowering the cost of loans. For businesses, this translates to cheaper access to capital, which can stimulate spending, investment and growth. Conversely, when central banks increase the cost of borrowing, it can suppress spending and slow the economy.
For small businesses, changes in rates can create both opportunities and challenges. Understanding how interest rates affect the business environment can help small business owners make better financial decisions and seize opportunities for growth.
Positive Impacts of Interest-Rate Cuts on Small Businesses
We’ll start by looking at how small businesses can benefit from lower rates:
Lower Borrowing Costs
One of the most immediate benefits of interest-rate cuts for small businesses is the reduction in borrowing costs. Business loans, lines of credit, and other small business financing options become more affordable when interest rates fall. For businesses that are planning expansions, purchasing equipment or funding new projects, these cheaper loans can provide the necessary capital at a reduced cost.
Also, when interest rates fall, businesses can refinance existing debt, potentially saving them significant sums on interest payments over time.
Expansion and Investment Opportunities
In a similar vein, interest-rate cuts can present small businesses with an opportunity to expand. Whether through acquiring new assets, opening additional locations or investing in research and development, lower borrowing costs make capital investments more attractive.
When businesses feel confident that they can borrow money at lower rates, they are more likely to take risks and pursue growth opportunities that they might have otherwise avoided in a higher-rate environment.
Relief for Cash Flow Challenges
Small businesses often experience cash flow issues due to fluctuating revenues and expenses. Interest-rate cuts can offer relief by lowering the cost of working capital loans or lines of credit. This allows businesses to bridge cash flow gaps more affordably.
For example: A seasonal business that experiences peaks and valleys in sales might find it easier to manage its cash flow with access to cheaper short-term financing.
It’s the gift that keeps on giving. Lower borrowing costs can improve cash flow management, which can reduce the risk of late payments to vendors or missed payroll. In turn, this can help businesses maintain stronger relationships with suppliers and employees, which are critical to long-term success.
Increased Consumer Spending
Consumers benefit from rate cuts, too — especially when it comes to loans and credit card rates.
It’s pretty easy to understand. Just like with small businesses, when consumers can access more affordable financing, they become bolder about spending. Lower mortgage rates can boost housing markets, for instance, while reduced car loan rates may stimulate auto sales.
Even if they’re not utilizing these products, they might feel more confident in their financial stability, making them more likely to increase discretionary spending on smaller goods and services. Indeed, small businesses in retail, hospitality and services industries can see a rise in sales amid lower interest rates — even if rates aren’t part of the discussion for those expenditures.
Challenges of Interest-Rate Cuts for Small Businesses
It’s not all positive, of course. There are at least a few potential downsides to rate cuts that small businesses should be aware of.
Increased Competition
You’re not the only one who gets to benefit from interest-rate cuts. Competitors will have the same access to that cheap capital, which means they too might begin to borrow and invest in their own expansion efforts. The result is often increased competition in the marketplace.
Reduced Margins Due to Inflation
Interest-rate cuts are designed to stimulate economic activity. And if they stimulate it too much, the result can be higher inflation. As more businesses and consumers borrow and spend, prices for goods and services might rise — putting pressure on small businesses to increase wages, pay higher prices for materials or face higher operating costs in general.
Inflationary pressures can erode profit margins, making it more difficult for small businesses to maintain the same level of profitability. In some cases, businesses might need to raise their prices in response to inflation, which can be risky if consumers push back against higher costs.
Potential for Debt Accumulation
Small businesses might feel emboldened by rate cuts, but they risk debt accumulation. And if a business takes on too much debt, it might struggle to meet its obligations — especially if interest rates actually rise again (if their debt is variable-rate in nature and thus the interest charged on those existing loans goes up). Thus, small businesses need to carefully assess their financial health and borrowing capacity before taking on new debt.
Why Could Interest Rates Drop Soon?
While none of us know what the future holds until it happens, it looks exceedingly likely that America’s central bank will finally reduce the “Fed funds rate,” which has been sitting at a target range of 5.25% to 5.50% since July 2023 — the last of the Federal Reserve’s inflation-combatting rate hikes.
We say “finally” because most economists and strategists largely expected the central bank to start cutting the Fed funds rate earlier this year. Exactly when the Fed would begin hacking away at interest rates, and how many times it would cut, were both open questions, though expectations were largely for “early and often.”
Clearly, that didn’t materialize. At least, not yet.
That said, thanks to a raft of data indicating a slowing economy and rising unemployment, the Federal Reserve seems poised to make a change during the next Federal Open Market Committee regular meeting, slated for Sept. 17-18.
Don’t Let Interest-Rate Changes Catch Your Business by Surprise
Interest-rate cuts can have a significant impact on small businesses, offering a mix of opportunities and challenges. But do you know how your company is positioned to harvest those benefits — or withstand the pressure?
If not, reach out to McManamon & Co. We offer a full spectrum of business services, including accounting, tax and outsourced CFO. We also offer consulting services, where we can talk to you about how interest rates could impact your cash flow, corporate growth and more.
If you want to learn more or you’re ready to get started, call us at 440.892.8900 or contact us online.
Tags: financing, small business, small business accounting, small business finances, small business financing | Posted in McManamon & Co., small business, Small business finances