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Entrepreneurs looking to start a business, purchase equipment, or expand operations may be faced with yet another obstacle impeding their small business journey — the soaring cost of borrowing money.

The Federal Reserve recently raised the federal funds rate, the interest rate at which banks borrow and lend money to each other. In turn, the fed funds rate also influences the rates that lenders offer their customers.

While interest rates on business loans will vary by lender, loan product, and borrower attributes, money is getting more expensive to borrow across the board, and there are indications more rate hikes are in store for the coming year.

So what can you do as a business owner to avoid getting caught off guard?

1. Plan on higher costs of funding

Many businesses rely on loans, lines of credit, and credit cards to fund expansion and cover temporary cash flow shortages. With interest rates rising, you’ll likely need to plan for higher interest rates on your existing variable rate loans and new borrowing.

Be sure to factor in higher monthly payments as you’re making your business budget or cash flow projections.

2. Consider refinancing variable rate debt

If you have a considerable amount of variable-rate debt, it might be time to refinance into a fixed-rate loan. 

The rise of interest rates has only just begun, so you may be able to act quickly, take advantage of current rates before they climb higher and refinance into more predictable monthly payments.

Business owners with strong personal and business credit, healthy revenues, and cash flow are in a good position to shop around and negotiate the best rates and terms on small business loans.

3. Look at alternate funding sources

Businesses without stellar credit and a history of profitability might have a tough time getting a bank loan. In that case, you might need to seek funding outside the traditional banking system.

Alternative funding sources include:

  • Crowdfunding sites (e.g., GoFundMe)
  • Peer-to-peer (P2P) loans
  • Online lenders
  • Merchant cash advances
  • Personal loans
  • Microloans
  • Business credit cards and lines of credit
  • Invoice factoring
  • Equipment financing

These borrowing options can be especially helpful when you need to borrow a small amount of money quickly — alternative lenders tend to be much faster than banks or credit unions in terms of both application approval and funding. However, if high interest rates are your main concern, some of these options may be a poor fit; merchant cash advances, for example, can have rates that hit triple digits. As always, shop around to make sure you get the best deal.

4. Plan for higher purchasing costs

A combination of inflation and higher interest rates may also force your suppliers to raise prices, which, in turn, increases your costs.

You generally have two options for dealing with higher purchasing costs:

  • Raise your prices. You can pass cost increases onto your customers. But remember, your customers are likely also feeling the impacts of inflation and interest rate hikes. Raise prices too much, and you may lose business.
  • Keep prices the same. Maintaining your prices might make them more affordable compared to your competitors, leading to new customers and more sales. But first, run the numbers to make sure you can afford to absorb higher costs without putting your business in jeopardy. Can you cut costs elsewhere or streamline processes to ensure this strategy won’t negatively impact your bottom line?

5. Focus on building cash reserves

Building up your cash reserves can be tough when dealing with higher interest rates, but it can help protect your business in the event that unexpected expenses pop up or revenue drops. This is particularly true for small businesses with limited access to credit.

One common rule of thumb is to keep enough cash on hand to cover three to six months' worth of business expenses, but there’s no one-size-fits-all amount. If you have few fixed expenses and can operate on a shoestring budget for an extended period of time or have access to a line of credit or another source of cash, you may be able to get by with a smaller business emergency fund. On the other hand, if your business is in a growth stage and you’ll need to continue spending money on payroll, inventory, and debt service payments, you may need more than six months of cash reserves.

Looking toward the future

Talk of rising interest rates, inflation, and recession can be scary for small business owners. However, keep in mind that the ultimate goal of raising interest rates is to slow down inflation, but not so much that it sends the economy into a recession — a strategy known as a “soft landing.”

Interest rates aren’t going to soar overnight, so you might not start feeling the effects next week or even next month. Still, it’s a good time to look at your business’s borrowing and cash flow and start making plans for the future. Locking in access to credit at low interest rates, streamlining where you can, and building cash reserves are smart moves, no matter what’s happening in the economy.

About the Author(s)

 Maxime  Rieman

Educating and assisting shoppers about financial products has been Maxime Rieman's focus, which led her to joining CoverWallet, a startup dedicated to simplifying insurance for small businesses.

Director of Online Channel Product Marketing, CoverWallet
Thoughtful businessman at computer