Interest Rate Increases: 4 Concerns for Small Businesses

Ability to service debt

According to the MetLife-Chamber poll, 39% of small business owners have taken out a small business loan to offset higher costs in materials and supplies resulting from the surge in inflation. But they are already seeing the impact of interest rate hikes on their ability to borrow and pay back debt: 6% of small business owners in the NFIB survey reported paying a higher rate on their most recent loan, for instance, up two percentage points from January. [Related content: A Guide to Choosing the Right Small Business Loan]
Though that’s currently just a tiny percentage, the need for stable and recurring financing will likely mean more small businesses will seek loans or other lines of credit, which will in turn increase their costs to service that debt, particularly if the interest rate is variable instead of fixed.  

To be sure, Tomic said, small businesses should avoid drawing down lines of credit or taking out new loans if possible until there is more clarity around the frequency and level of interest rate hikes. For businesses that absolutely need a loan, he says to secure a fixed rate that won’t fluctuate based on the Fed’s interest hikes. 

Exacerbation of worker shortages

Over the last two years, tens of millions of workers have left the labor force, leaving large and small businesses alike struggling to fill open positions. For those workers who remain, it is not uncommon to see their salaries increase by half or even double what they were making. Overall, wages and salaries rose 4.4% last year, the largest increase in 20 years, and they are expected to rise by another 4% this year. 

Zoltan Acs, director of the Center for Entrepreneurship and Public Policy at George Mason University, said the need to pay back or finance loans could impact the ability of small businesses – already hit hard by wage inflation – to meet their hiring needs. “They may not be able to compete for workers on pay.” 

With the pressure already placed on small businesses by the Great Resignation and a competitive labor market, inability to offer attractive compensation plans could lead to more staffing challenges. But Acs said small businesses don’t have to compete for talent on the basis of wages alone: They can emphasize their culture, purpose, and social impact to appeal to talent that is increasingly leaving larger firms because they want to make a difference. 

Ability to forecast inventory needs

One way small businesses have sought to mitigate the impact of inflation and supply chain disruption is by carrying more inventory. Accumulated inventory can act as a hedge by locking in prices before they increase.

The problem is when those savings are offset by the need to transport, store and distribute that inventory. After all, small businesses don’t have huge factories in multiple locations across the country to house their goods. 

“Balancing the costs of carrying extra inventory with the normal cost of doing business isn’t easy,” Tomic said. 

That’s especially true for small businesses, whose cash flow is likely to be further constrained by rising interest rates. In fact, after building up inventory during last year’s fourth quarter, small business owners have started to pull back this year. About 7% of owners in the NFIB survey said the current inventory stocks were “too low.” However, underscoring concerns about how interest rate increases will impact cash flow, only 2% plan to increase inventory in the coming months.

Given the supply chain constraints facing businesses, Tomic advised small business owners to reassess their forecasting models and make adjustments to add or reduce inventory on a monthly basis for at least the remainder of the year. 

Slower growth

For small businesses that have thus far survived the pandemic, now is an ideal time to reinvest and expand to gain market share and solidify their competitive position – or it would be if the frequency and size of interest rate increases were more certain, as most small businesses finance expansion with a combination of equity and debt. 

In a recent QuickBooks survey, for instance, small business owners cited the need for “increased access to capital” to grow. Startups born out of the pandemic (meaning those less than 2 years old) and new entrepreneurs planning to launch businesses could be especially vulnerable, according to Acs. 

Acs advised startups and entrepreneurs that need capital to consider alternative financing options such as venture capital, private equity, loans from family and friends, or even personal savings. But he added that “small businesses may have to curtail whatever growth plans they had for this year,” whether it be leasing a new property, launching into a new market, or offering more products and services. 

What’s next for interest rates?

Right now, even with at least two more increases likely to come before the summer, interest rates are still relatively low. The question experts are trying to answer is if the inflationary environment is a prolonged systemic issue or just a temporary pressure point. 

Acs said the Fed’s current approach signals more of a change in direction than an overt attempt to slow the economy, but that could change as the year unfolds. He added that if it becomes clear that inflation is systemic, the Fed could start pushing rates up to 4% and beyond, which would definitely sound a major financial alarm for small businesses. 

“Small increases add up,” Acs said, “and if rates are raised enough to choke off the economy, that could hurt small businesses.”