With interest rates increasing at a rapid rate, it is vital as a business owner to understand the impact this has on your company. It is also very important to take proactive steps to improve the situation for you and your business.
The history of the RBA benchmark rate shows a roller coaster. Hitting a record low of 0.10% on November 4, 2020, it stayed at this record low for around a year and a half. On May 4, 2022, the RBA increased rates by 0.25%, then a 0.50% increase in June 2022, followed by a 0.50% increase in July 2022. This may seem like a rapid rate rise, however as you can see below in the long-term scheme of rates, they are still very, very low.
So what does the future hold for interest rates? Nobody has a crystal ball; however, several people believe the RBA cash rate will rise to circa 2.5% by the end of the 2023 calendar year. That is a 2.4% increase in interest rates in around 20 months.
The next question is what action should you take in response to increasing interest rates? This depends upon whether you have cash or debt.
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If you have cash deposits, you should setup a high interest savings account. As the RBA cash rate is low, so are the savings rates. If you can get 1% plus today, that is a good rate. For excess funds you don’t need in the short term, you should consider a term deposit. As the expectation is that interest rates will rise, this means term deposit rates are higher than at call savings. Such as 3% for a one year or 4% for a three-year term deposit. It is important to analyse your cashflows to ensure that certain funds are not needed for the deposit period, as early exit can mean a significant loss of interest.
The final strategy is to potentially use these excess funds outside the business to reduce non-deductible debt, such as a mortgage on a main residence. If your mortgage rate is 3% and your marginal rate of tax if 39%, then using this strategy is effectively achieving 4.9% before tax. Be careful though that you don’t spend the money once it leaves the business bank account!
If you have debt/borrowings, you should look at refinancing. You should never be loyal to a financial institution. You are rewarded as a new customer, so should review all debt at least annually to ensure you have the best rates and fees for your circumstances. The other strategy to consider is to reduce gearing/borrowing and slow growth to hedge against increasing interest rates and slowing economic growth. This means that your business is more likely to ride out the poor economic conditions and still be around when the economy improves.
For those of you who don’t mind a spreadsheet (or engage an accountant) a sensitivity analysis for sales slowing or interest rates increasing would be worthwhile. This allows you to model the impact of these two changing variables and forecast the impact to your cashflow and bottom-line profitability.
The reason for the interest rate increase is for the most part inflation, which nationally is sitting at around 5%. This means that in 2023 financial year, you must make 5% more profit to effectively be in the same position you were in the prior 12 months. Your costs are likely to go up by this amount and ethically your wages should also go up by around this amount. Hence, with costs rising, you need to increase your prices to keep up with inflation.
It is vital that you monitor the rapidly changing situation with interest rates and the flow on effects, as well as make positive change for your business for the future.