By Dave Costello, TCV Growth Partner
Since March 2022 interest rates have risen 450 basis points, that’s 4.5%. The federal funds target rate has risen from a range of 0% to 0.25% in March 2022 up to a range of 4.5% to 4.75% today. And based on recent economic news it sounds like, looks like, interest rates will rise even further!
If you are a business owner who is borrowing to finance portions of your business, you likely have seen the Prime Interest Rate rise from 3.25% prior to March 2022 up to 7.75% today. That is a dramatic change in interest expense flowing though on your P&L on a monthly basis.
As a business owner what can you do, what should you be doing? Cursing Jerome Powell, the Federal Reserve Board Chair, won’t help. You need to take action steps. Consider the following suggestions to help you sleep better at night and get more control of your business.
1. Review the prices you are charging your customers for goods and/or services:
Remember the reason that rates are higher now is that the Fed is fighting inflation. Virtually all goods and services cost more now than a year or two ago due to inflation of 6.5% in 2022 and 7% in 2021. Your costs for salaries and materials to sell in your business have likely risen because of this. Have you passed on these cost increases to your customers to the extent that you can? Maybe you can’t pass them on at 100%, but if you haven’t raised your prices to the extent that you can you are doing your business a disservice. Raise your prices if you can! All other factors staying the same, this should help improve your cash flow.
2. Review your spending:
Every business experiences spending creep and inefficiency over time. Take a hard look at what you are spending money on. Ask yourself if you really need that item, whatever it is, to run your business. Areas to look at are magazine or newspaper subscriptions (how many of these come in and sit on a table somewhere but no one picks it up or reads it), training programs, frequency of janitorial services, size of trash dumpsters, copiers, fax machines, outside storage space, cell phones, etc., etc., etc. There can be no sacred cows in this kind of review, and you can’t play favorites. Also, when was the last time you rebid the snow removal contract to clean your parking lots? There are lots of hungry service providers out there that will do the same job less expensively. Look at your vendor contracts! There could be gold sitting there waiting to be discovered!
3. Accelerate pay down of debt:
A few years ago, with interest rates essentially at zero, management of cash was not as critical as it is today. If you had a few extra dollars in cash accounts or a few extra dollars in borrowings it didn’t really matter too much since you couldn’t earn anything on the extra cash and the extra borrowings wasn’t costing that much. Times have changed!! If you are borrowing today the cost is much higher as noted above. So if you have a little excess cash sitting in your checking account use those funds to pay down your debt. You will be saving a minimum of 7.75% if not more, based on your bank’s credit spread to your line cost!! There are not too many places today where you can get that kind of return!
4. Collect receivables timely:
Are you financing your customers? Is that a conscious decision? You should have a process in place that ensures timely collection of your accounts receivable. You want to be accommodating to a point so that customers will want to do business with you, but are they using you as their bank? If you are borrowing to finance your receivables its costing you 7.75% or more! Have someone contact customers whose invoices have been outstanding for 30 days. The script is 1) just want to make sure you received the invoice, 2) want to make sure there was no problem with the work or item, and 3) can we expect payment in the next five days? It’s not a threatening message. You are just providing good customer service! But it also sends the message that you need to be paid timely for the work you performed or the items you sold them. After all, that is what your customers want from their customers as well!
5. Prepare a cash flow forecast:
A cash flow forecast can be extremely helpful in any business, but especially if you are bumping up against your line of credit limit. If you are, your borrowing costs are likely pretty high and depressing your company’s earnings. A cash flow forecast can help in planning for debt pay down as noted above. I suggest a 3 month forecast at a minimum, broken down by week if you can. Yes, its tedious and time consuming, and sure its never accurate 100%. However, it is a very good tool for managing cash when cash is tight. Strategies that can be helpful in this situation are delaying fixed asset purchases, such as cars or trucks or equipment, push out inventory purchases, evaluate inventory turnover so you don’t have inventory sitting around too long, discount sale prices of older inventory items to convert them into cash sooner, or negotiate short term extended payment terms with vendors. You don’t want to do anything that negatively impacts your operations but there are things you can do to help preserve or manage cash in situations where cash is tight.
6. Invest excess funds:
If you are in the enviable position of not having to borrow then take a look at your cash situation. If you have excess funds, you should be investing those short term. You can earn 4.50% plus on 4-week treasury bills these days. I advise my clients in this situation to build an investment ladder of 4-week, 8-week and 13-week treasury bills so that you have maturities every month. You can also build a ladder using 4-week treasury bills only so you have maturities each week. These investments can be often made with your bank, with your broker, or you can handle it online directly with Treasurydirect.gov. Rates are not going to fall in the near term and treasury bills are state tax exempt so there’s an extra benefit. Make sure you are taking advantage of this rate environment and investing excess funds. You can also do this in your personal investments if you have some cash available to invest.
So stop wringing your hands and cursing Jerome Powell - take action to improve your business. If you need help with any of these suggestions or have questions you would like to discuss further feel free to email me at firstname.lastname@example.org. I’m happy to have a conversation to help get you on the right track.