How Small Business Owners Can Hack the Fed’s Interest Rate Drop

How To Hack the Fed's Interest Rate Drop

After a series of increases over the past year and a half, July marked the Federal Reserve’s decision to push the first interest rate drop since 2008. Their efforts come at a time when many feared a downturn. The vote of 8-2 triggers a small rate cut. It was designed to keep the historically long economic expansion going strong. The change will set interest rates at between 2 percent and 2.25 percent. This affects everything from consumer mortgages and car loans to small business investments and credit card debt.

This news isn’t welcomed by investors who were enjoying a bump in savings rates. However, the change can be a boon for many small business owners. Borrowing will now be cheaper, if even just by a bit. Depending on how much debt you have, you may use some of that interest savings for your own growth goals.

With so many options available, you might not know where to begin. Here’s what the experts suggest you do to take full advantage of the new changes.

Review your capital structure

While there are several paths you can choose to maximize this time in the market, Small Business Consultant Andrea Travillian recommends taking a step back and assessing your financial health.

“The first thing you should do is review your capital structure,” Travillian advises. “As rates are dropping, it may be a good time to reallocate how much financing is from debt and how much is from equity.”

After this, a wise move would be to redo cash flow projections. “This will allow you to see exactly how much of a difference it will make on your business.”

With a better view of your company, you can choose to move forward with one – or more – of the following plans:

  1. Repay debt

Making additional or larger payments on your existing debt can accelerate progress and get you out of debt sooner. Travillian reminds us that it’s a wise way to lower overhead, too. Put more of your money toward your business, instead of paying the bank.

  1. Refinance debt

Fed rate reductions are an ideal time to take advantage of low rates. Refinancing floating rate debt to a fixed loan gives you the added benefit of knowing exactly how much you’ll spend in payments each month. You can also plan around how long repayments will take. “It makes cash flow easier to predict,” says Travillian.

  1. Reallocate money for growth

There’s also an option to pay yourself first. Instead of handing the extra over to a lender, you could reinvest the funds into your own company. Businesses can use the extras to make much-needed upgrades in operations, product, or personnel.

Kassandra Dasent, CFEI, suggests companies review goals for the next 12-24 months. Then, consider spending on these pre-established company objectives. However, Dasent cautions business owners without sufficient cash reserves to “address essential operating expenses in the event of a downturn. Allocating excess funds to cover this should be considered a priority.”

  1. Make no changes

One final choice is to keep things as is. Depending on your debt level, you may not experience much savings. For some companies, the interest rate reduction won’t cause enough difference to warrant the energy used to change course.

Big. vs. small goals

The next steps should be tailored to your company’s unique growth and savings goals, and some of that will be determined by the size of your endeavor. “The larger and more established the company, the more options they have to manage the interest rate fluctuations,” shares Travillian. A Fortune 500 company, for example, is better-poised to deal with ups and downs of the market. Tools available to them, specifically, may include futures, options, and interest rate swaps.

Startups, on the other hand, are limited in how much they can squeeze out of this opportunity. In these cases, “the debt levels may not warrant taking these measures,” she admits.

Dasent says smaller companies could benefit from seeking a new round of financing. Another option is to “access new lines of credit to infuse needed cash into their business at a cheaper rate of interest.”

Assess your debt situation

Debt levels vary, and those with low debt levels won’t see the same impact of the rate reduction. If nothing else, paying down debt faster is a simple way forward. A business could use it as an opportunity to buy smaller businesses with debt to grow their own faster.

“Those with higher levels,” Travillian shares, “would use it as a time to find better deals and then, either move or negotiate to lower levels.” The extra wiggle room in cash flow could lead to new opportunities for growth.

Know how the market works

Travillian encourages business owners to know the reasons behind this — and future — interest rate reductions. Depending on why it’s happening, your course of action could vary. She explains that the Fed might do this for one of two reasons. They could do it as an effort to keep inflation low during a thriving economy. In this case, it’s used as a stimulant for what they see might be a slowing economy. These interpretations have very different outcomes for companies.

“If the economy is slowing, there will most likely be more rate reductions,” she explains. “You need to determine what happens to your business during a downturn. Do you need to save for slower sales? Is your business one that sales can increase during slower times? These things should factor into what you do with the extra cash flow.”

Travillian shares a simple litmus test for businesses unsure with how to move forward, as well. “One of my favorite questions to ask is: ‘if growth goes to zero, can your business survive on your current revenues?’ Use this answer to help guide what you do with funds.”

She also recommends business owners reach out for professional advice if there isn’t a clear path to take. A CFO or CPA trained in helping you make those decisions will get the best capital allocation for the most profit.

Take your time

If there’s nothing else to take away from this news, it’s that markets change all the time, but knee-jerk reactions won’t likely benefit anyone. Travillian reminds businesses that there’s no need to rush into whatever decision you make from the Fed’s latest move. “You have time to make the right decisions,” she cautions.

Dasent also cautions companies to not overextend themselves during this time. “World economies, including that of the US, are slowing down. It is being reflected in an inverted yield curve, which can signal an eventual recession. This means that financial and other lending institutions will consequently adjust their risk models to prevent corporate default which would in turn result in a tightening of access to credit.”

While what the Fed does next is anyone’s guess, some have hinted that this interest rate drop may be the first in a trend. It’s best to approach each new rate change as a significant opportunity to keep your business reaching its growth goals.

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