Focusing on Cash Flows in a Climate of Higher Interest Rates

By Kristen S. Jerome, CPA
Partner, Bauknight Pietras & Stormer

Back to the Basics of Cash Flow Management 

In the decade following the 2008 financial crisis, the Fed kept interest rates at historic lows to stimulate the economy and incentivize consumer spending. During 2023, we watched interest rates steadily rise, peaking in mid-October at a 23-year high.

Higher interest rates have a cascading effect on almost every aspect of a company’s financial health, not just on interest expense.  Both short-term and long-term liabilities become more costly. Customer credit risk increases. Supply chains can seize as a result of business failures. Consumer spending decreases, which puts downward pressure on revenues across the economic spectrum. All of this translates to cash flow risk.

In times of higher interest rates, managing cash flows becomes a paramount concern for businesses aiming to maintain financial stability and sustainable growth. So, let’s revisit the basics of cash flow management:

1. Refinancing and Debt Restructuring: In an environment of rising interest rates, consider evaluating existing debt structures. Explore opportunities for refinancing or debt restructuring to mitigate the impact of higher interest rates. By negotiating favorable terms with lenders or exploring alternative financing options, you can potentially lower interest expenses and improve cash flow.

2. Effective Working Capital Management: Efficient working capital management becomes crucial during periods of higher interest rates. Focus on optimizing inventory levels, improving accounts receivable and payable cycles, and streamlining operational processes. Even the smallest efficiencies have a compounding impact on your balance sheet. Tightening controls over working capital can enhance your liquidity, providing a cushion against increased borrowing costs.

3. Diversification of Funding Sources: Relying on a single source of funding can expose businesses to greater risks during times of higher interest rates. It’s a good time to diversify your banking relationships as financial institutions are constantly recalibrating their own risk appetites for certain industries and financial tools. Also consider diversification of your funding sources, incorporating a mix of equity and debt financing. By reducing your dependence on any single lender or type of financing, you create flexibility and resilience within your firm.

4. Interest Rate Hedging: Explore financial instruments, such as interest rate swaps or options, to hedge against the adverse effects of rising interest rates. Though its crucial to carefully assess the risks and costs of financial instruments, these tools lock in predictable, and maybe even favorable, interest rates providing for better cash flow planning.

5. Adding Value: As consumers hesitate to part with their pennies, double down on your competitive advantages. Do your sales team a favor by investing in greater value-add services to complement your current offerings. Offset costs with continuous productivity improvements.

You may be thinking these are no-brainers, and you’re probably right. But consider the possibility that we’ve grown complacent over the past 10-15 years, as profitability can hide all manner of sins. Get back to the basics of sound cash flow management to position your business to sustain and even thrive in a dynamic and evolving financial environment.