The conversation dominating newscasts, corporate boardrooms and family dinner tables today is inflation and high interest rates.
Today’s current interest rate environment is a challenge that entrepreneurs haven’t faced in more than 20 years. Since March 2020, the Bank of Canada’s overnight rate has increased 4.25 per cent, with bank prime rates at their highest levels since April 2001. Although these rising interest rates may seem overwhelming, you can take steps to mitigate risks and control interest expenses. If you’re a business owner, here are some strategies to consider:
1. Understand your cost of capital
Businesses today often have a variety of lending products. It is not uncommon for a business to have an operating line of credit, credit cards, a mortgage and term loans. It is important to understand what your interest rate is for each facility and reduce balances on your highest interest product. For example, credit cards often have the highest annual percentage rate (APR). If you have available room on your operating line, using this to pay down credit card balances would reduce interest costs.
A simple strategy would be to list all your existing debt and interest rates. Meet with your advisor to see which obligations can be refinanced with less expensive products. You may be able to give additional collateral in exchange for lower rates.
2. Balance variable and fixed interest rates
In previous low interest rate environments, businesses and consumers often chose variable (floating) interest rates as this was usually the lowest rate. Today, fixed rates are sometimes lower. Entrepreneurs should ask their lenders for current options on their debt to find potential savings in choosing a fixed rate. Having a mix of fixed and variable rate debt is wise for a business to manage its risk. Fixed rates create cost certainty and protection from any future increases, while having some variable rates allows the business to benefit from future rate decreases.
As a business owner, you should consult your advisor for different lending products to hedge interest rate risks, as well as laddering strategies when choosing fixed rates.
3. Revisit your projections and covenants
It is important for entrepreneurs to understand the impact high interest rates will have on your cash flow and how this will affect their banking covenants. Once higher interest rate products are paid down where possible – and fixed rates are reviewed – the business’ projections and cash flow forecasts should be updated with these new interest costs.
Businesses should be forecasting their cash flow to identify issues ahead of time. Depending on the type of business, this cash flow forecast could span out 12 weeks or more. If you notice periods where cash will be tight, it is important to discuss this with your advisors and lenders ahead of time to come up with the best strategies.
Lenders often have financial covenants for borrowers. This can include debt‑servicing covenants (can cash flow support lending obligations?), and leverage covenants (does the business have enough equity to cover its debt?). As a business owner, you should be updating your company’s projections to identify potential covenant breaches early on and discussing with your lenders ahead of time.
Although the interest rate environment is out of your control, the strategies above can help to reduce interest expenses, mitigate risks and protect your business by working with your partners.
Baker Tilly Windsor’s corporate finance advisors can support you with actionable insights and customized solutions. Whether it’s analyzing the cost of capital, balancing lending products or revisiting projections, trust your Baker Tilly advisor to maximize opportunities and minimize risk. As a full‑service advisory firm, corporate finance is one of the many specialty services we offer to help our clients take a holistic approach to their business planning – and their success.
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