(As originally published in The Globe and Mail, 18 July 2017)
How can small businesses handle rising interest rates?
By: Elizabeth Maccabe, EY Canada’s Private Client Services Assurance leader
On July 12, 2017, amid wide speculation, the Bank of Canada raised its benchmark interest rate for the first time in seven years. All indications suggest that the positive and upbeat outlook for the Canadian economy signals a turning point toward a longer-term trend in rising interest rates in Canada.
Small to medium-sized private businesses may be one of the most affected groups by the rate increase. According to Statistics Canada’s Key Small Business Statistics report, over 50 per cent of small to medium-sized enterprises in Canada sought external financing, and 80 per cent of startup companies have used personal financing to fund their new businesses. That adds up to a lot of businesses that will inevitably experience the pressure of rising rates.
So what can Canadian private businesses do today to prepare for potential impacts of a higher interest-rate environment?
Revisit your business plan
An increase in interest rates can affect an owner’s ability to grow the business and stay profitable. In an environment of increasing interest rates, banks charge more for business loans. Companies that have loans with fluctuating interest rates may experience challenges in paying them back. This could lead to reduced profitability, which in turn can make it harder to secure additional funding.
It’s critical to revisit your business plan and determine the best course of action for your short-term and long-term growth objectives. Ensure that your plan accounts for possible further rate increases and leaves enough room for important capital required for innovation and reinvestment activities that will help you sustain your growth momentum.
Evaluate your debt levels
Now is a great time to revisit your existing levels of debt. To avoid getting caught in a debt pitfall, it’s up to you to get the financial facts on your business and make sound borrowing decisions. An important – and often overlooked – step is to determine whether your existing type of debt is appropriate for the purpose of your business. For example, if you own a company with high seasonal inventory and accounts receivable, you may be better served with an asset-based lending arrangement instead of conventional debt. Determining the most appropriate type of debt for your unique business is key to surviving unanticipated rate changes.
Assess your covenants
With interest rate increases, it’s important to plan for the future and be aware of the big picture. When evaluating your debt repayment plan, you should work with your lenders and understand how much room you have with covenants, should the interest rate increase by 1 per cent to 2 per cent over the next few years.
You’ll also want to examine your debt-to-equity ratio. This can provide you with valuable information that can help you determine whether you need to pay down your debt, postpone borrowing plans or re-evaluate your transaction strategy to get you on the right track to profitability.
Financial analysis is essential to running a successful private business and growing in an era of rising interest rates. Early awareness of your stress points can help you streamline your cash-flow management and accelerate debt repayment. Have an open and honest dialogue with your lenders before problems occur. You’ll benefit from pro-active communication with your lenders.