All signs are beginning to point to higher interest rates. We can all hope that the historic interest rates stay and the Fed doesn’t move, but it’s better to be safe and prepared than sorry.
Take a minute right now to go get your last fiscal year end financial statement. Go to the income statement and look up the interest amount. Next, double that figure and see if your company would still be profitable. If the answer is no, it’s easy for you to try to ignore the results by thinking this drastic of a change is unrealistic, but, is it?
Perhaps you think that 10% to 10.5% is more realistic. Fine! Then take last year’s interest and multiply the number by 1.25. Now would you be profitable?
If the answer is no, you may have your company too leveraged (too many loans) for the level of profit your company is producing. You have two choices — pay down your loans or become more profitable.
To easily check your company’s leverage, calculate your debt to worth ratio. This ratio includes all of your liabilities, not just loans. Divide your total liabilities by your net worth (stock and retained earnings). If the result is a ratio of more than three-to-one, your company may be too highly leveraged. To overcome this predicament, you need to get rid of some liabilities and to work diligently on cash flow and profitability.
If your leverage is less than three-to- one, but you still didn’t meet the higher interest test, it’s just a matter of too-low profits.
If you passed both tests, congratulations! Your company will be able to operate safely in a higher interest rate environment, but you should still consider the following strategies. These strategies also apply to high leverage or low profit companies during times of rising interest rates:
• Lock in fixed rates on new long term loans.
• Request the longest term financing you can get with your fixed rate deal. For instance, on real estate projects, if you can get a 20 year note, go for it. Or, a 15 year note is better than a 10 year note, which is better than a five year note.
• Consolidate and refinance small, multiple variable rate loans into one larger fixed loan. There is a high administrative cost to making all those individual payments.
• Refinance pending balloon payments early. Rather than waiting until the end of the loan term when rates may be significantly higher than today, request loan extensions at fixed rates now.
• If you use an annual line of credit for equipment purchases and have already built up a significant balance, request the balance be termed out now (instead of at your year-end) at a fixed rate and a new, smaller line of credit established for the remainder of the year.
• If you have pending projects, get your financing (including rates) locked in now, even if you must pay a small fee for the privilege.
• Avoid any long term CD investments. Keep your spare cash liquid as rates rise so you can take advantage of investing at the higher rates.
Interest rates are always a bit of a gamble, but it’s always better to be safe than sorry.
