Interest rate increases do not just affect homeowners and mortgage repayments. They can have a significant impact on businesses, particularly small and medium-sized businesses that rely on finance, carry stock or equipment, or are already operating with tight cash-flow margins.
With borrowing costs increasing, businesses need to look beyond the interest rate on their loan and consider the broader effect on customers, cash flow, profitability and investment decisions.
The cost of borrowing is going up
The most obvious impact of higher interest rates is an increase in the cost of business finance. Businesses with variable-rate loans, overdrafts, equipment finance or other borrowings may see their repayments increase. Even businesses with fixed-rate loans will eventually need to consider what happens when their existing facility expires or is refinanced.
For a business carrying substantial debt, even a relatively small increase in the interest rate can have a meaningful impact on annual profitability. For example, an additional 1% interest on $1 million of borrowings represents approximately $10,000 a year in additional interest expense, before considering the effect of compounding or changes in the loan balance.
Cash flow becomes even more important
When interest costs rise, businesses need to pay closer attention to cash flow. A business may be profitable on paper but still experience cash-flow difficulties if customers are slow to pay, stock levels are too high or loan repayments consume a significant portion of available cash.
Business owners should regularly review:
- outstanding customer debts;
- payment terms;
- stock levels;
- supplier payment arrangements;
- loan repayments;
- overdraft facilities;
- tax and superannuation obligations; and
- expected cash inflows and outflows.
A current cash-flow forecast can be one of the most useful management tools during periods of economic uncertainty.
Customers may also be under pressure
The effect of higher interest rates does not stop with your own business. Your customers may also be dealing with higher mortgage repayments, higher business finance costs and increasing household expenses. This can lead to reduced discretionary spending.
For businesses in industries such as retail, hospitality, building, renovation, recreation and professional services, a reduction in customer spending can quickly affect turnover. Business owners should therefore avoid assuming that historical sales levels will automatically continue.
Think carefully before taking on new debt
Higher interest rates make it more important to assess whether new borrowing will genuinely generate an acceptable return. Before borrowing to purchase equipment, expand premises, increase stock or acquire another business, consider:
- Will the additional income generated by the investment comfortably cover the additional finance costs?
The answer should be based on realistic forecasts rather than optimistic assumptions. It is also worth considering what would happen if sales were 10% or 20% below expectations, or if interest rates remained higher for longer than anticipated. - Review your existing loans
Businesses should not simply accept their existing finance arrangements without review. It may be appropriate to discuss with your accountant and finance provider:
- whether the current interest rate remains competitive;
- whether the loan structure is appropriate;
- whether facilities can be consolidated;
- whether fixed or variable rates are suitable for the business;
- whether unused facilities should be cancelled;
- whether repayments can be restructured; and
- whether refinancing would actually save money after fees and other costs.
A lower interest rate is not necessarily a better deal if it comes with significant establishment fees, break costs or other conditions.
Watch your profit margins
Higher interest costs can quietly reduce business profitability. For example, a business may have maintained the same sales and gross profit but find that its net profit has fallen because interest expense has increased. This makes regular management
reporting particularly important. Business owners should monitor:
Sales → Gross Profit → Operating Expenses → Interest → Net Profit → Cash Flow Looking only at turnover can give a misleading picture of the health of the business.
Consider your pricing
If your business costs are increasing, it may be necessary to review pricing. However, simply increasing prices to cover higher costs may not always be appropriate, particularly if customers are already under financial pressure. Before changing prices, consider:
- your gross profit margin;
- competitor pricing;
- customer sensitivity;
- the cost of providing the product or service;
- financing costs; and
- whether some products or services are more profitable than others.
Sometimes improving the product mix and margins can be more effective than applying a blanket price increase.
Be careful with stock
Higher interest rates can also increase the cost of holding stock. Money tied up in excess inventory is money that cannot be used elsewhere in the business. Businesses should review slow-moving and obsolete stock and consider whether stock purchasing levels need to be adjusted. A lower stock holding can improve cash flow without necessarily reducing sales.
Tax debts and payment arrangements
Businesses experiencing cash-flow pressure sometimes delay tax payments. This can be dangerous. Tax debts can attract interest and penalties, potentially making the financial problem worse. If a business is experiencing difficulty meeting its ATO obligations, it is generally better to address the issue early rather than allowing debts to accumulate. A realistic cash-flow assessment should take into account upcoming BAS, income tax, PAYG withholding and superannuation obligations.
What should business owners do now?
Higher interest rates are a good reason to undertake a financial health check. Consider:
1. Review your debt: List every business loan, overdraft, equipment finance facility and credit card, including the interest rate and remaining term.
2. Prepare a cash-flow forecast: Look at expected receipts and payments over the next 3–12 months.
3. Stress-test the business: Consider what would happen if sales fell, customers paid more slowly or interest rates remained high.
4. Review margins: Identify which products and services are actually generating an acceptable return.
5. Review stock: Reduce unnecessary capital tied up in slow-moving inventory.
6. Review expenses: Identify costs that can be reduced without damaging the business.
7. Plan major expenditure carefully: Consider whether large purchases or expansion should proceed now or be delayed.
8. Talk to your accountant early: Don’t wait until cash flow becomes critical. Early financial modelling can identify problems while there are still options available.
The accountant’s role is more than preparing the tax return
Periods of higher interest rates highlight the importance of having up-to-date financial information.
Your accountant can help you assess the impact of higher borrowing costs, prepare cash-flow forecasts, review profitability and model different scenarios before you make major financial decisions.
The key is to use financial information as a management tool — not simply as a record of what happened last year.
Final thought
Higher interest rates can create challenges, but they can also be a useful prompt for businesses to review how efficiently they are operating. The businesses that understand their numbers, actively manage cash flow and carefully assess borrowing and investment decisions will be better positioned to respond to changing economic conditions.
If you haven’t reviewed your business finances recently, now is a good time to look beyond the profit and loss statement and understand exactly where your cash is going.