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September 26, 2022 | Article | 5 min

Amidst rising inflation and an uncertain economic environment, it is essential to find ways to optimize your cash flow—and strategies exist! Read more as we discuss the importance of sensitivity analyses and at how a hard look at billing practices and inventory can help.

This year, the U.S. Federal Reserve gave the nod for the biggest interest rate hike in 22 years. These rate hikes are the Fed’s main means of slowing demand for goods and services, thereby easing rising inflation—and the economy is in much need of any inflation curtailing right now. In July 2022, the inflation rate in the US hit 9.1%, the highest since 1981—and well above the Federal Reserve’s 2% target—driving the cost of goods and services sold sharply upward.

Person sliding over a wad of cash

However, while interest rate increases help the macroeconomic landscape, they can also have negative impacts on individual businesses. How can you optimize your cash flows to prepare?

Increasing Interest Rates—How Does It Affect Your Business?

The Covid-19 pandemic stressed businesses in many ways. The effects are everywhere, from temporary suspensions of business to extreme demand from consumers to supply chain snarls. Many enterprises had never experienced an economic downturn or had to ride out a recession or erratic market fluctuations. On top of all of this comes income interest hikes.

Increasing interest rates ripple across all markets, affecting businesses and consumers alike. When the cost of funds increases because of higher interest rates, buyers think twice about buying big-ticket items. Sales slow and stall, causing goods to accumulate—forcing prices back downward. Also, with higher interest rates and tougher lending standards, many businesses reconsider capex investments, slowing the rate of growth and expansion.

How rising interest rates affect a business varies by market sector. If a business offers professional services—think marketing, legal, or business planning, for example—that business may see either a downturn (due to reduced discretionary spending) or an uptick (because business owners seek advice during stressful times). But if the business focuses on goods, they can expect a double-hit: a slowing of sales to buyers and a rising cost of goods sold from suppliers.

Strategies to Combat the Increase

Though the Federal Reserve expects to raise rates in small increments three or four times this year, it may not be enough. Financial experts predict yet more aggressive raises to come in 2023.

Picture of the front of the federal reserve building

Businesses need to recognize the impact of higher interest rates and lay the foundation to thrive. Before adjusting prices as a quick Band-Aid on the problem, consider trying out a few practical steps that can optimize your cash flow during this time.

1. Turn Your Cash Flow into a Cash Cow

The one-two punch of inflation and interest hikes has seriously impacted the cash flow of many businesses. As inflation increased, the nominal amount of goods rose along every part of the supply chain. But when higher prices combine with rising interest rates increasing the cost of financing, buyers reduce spending—leaving businesses with high expenditures and reduced income.

If the business has been operating for a while and has an established cash flow, it may be able to better weather interest rate increases. Whereas a newer business, or those more sensitive to rate increases, may have a less than rosy future if incoming cash is tight combined with limited liquidity.

How can you adjust your cash flow to mitigate the blow? It comes with some creative planning. For starters, take a hard look at your cash flow forecast analyzing receivables, expense payments, sales trends, assets, capital plans for expansion, and new hires. Much like a detailed business budget, this should cover a specific amount of time: six months, a year, five years—however long you deem necessary.

From here, you can now explore creative solutions to optimize this flow. Look for ways you can accelerate receivables. If you sell goods that generally require financing, ask customers for partial payment upfront. Or, consider offering early payment discounts of 2% to 3% off the invoice if payment is received within a specific time, such as seven days. Though the discount can eat into profit margins, it can almost guarantee full payment on time, increasing your cash flow.

Ruthlessly evaluate all expenses and eliminate non-essentials. Pay bills right away if there is a discount for early payment; otherwise, pay the invoice right before it’s due to avoid late fees. Consider layoffs and other employee reductions as a last resort.

As you look at expenses, note any business loans the company is currently repaying. In troubled times, lenders may be more willing to provide repayment flexibility in the form of extended terms or lower payments. A true financial partner will be willing to work with good customers.

Further, increase cash flow by reducing inventory. Study customer demand and tweak future purchases accordingly; run a slash sale on excess stock. Raise prices on goods only as a last resort.

Finally, review plans for upcoming capital investments. In the current financial climate, strategically consider how to increase your production or positively impact revenue by expanding your product line or updating equipment against the cost of funds.

2. Prepare for the Lending Process

If you determine financing is the most effective option to meet your goals, take a close look at how sensitive your business is to fluctuating interest rates. Most lenders will conduct a sensitivity analysis on a business seeking a loan, using current and historical business data to forecast the potential impact of various economic conditions on a company’s finances in order to make informed decisions. The more debt a business has (or, the more leveraged it is), the more vulnerable it will be to interest rate risk.

Person reviewing documents

3. Adjust Prices to Mitigate the Cost of Goods Sold

Straight price increases shouldn’t be your immediate solution to fluctuations in the marketplace. Customers are observant; any quick changes could turn them off to your business. However, sometimes it is inevitable. Sustaining profit margins—especially in the face of increased supply-side costs—should be your guiding motive.

When you must adjust your pricing model, do so in a fashion that blunts the immediate impact. For example, you might implement a preferred pricing group, in which members receive lower prices by meeting certain criteria while the general public pays more. Businesses can also eliminate offering rush orders, small orders, and off-invoice discounts, and adjust volume discounts. Reinforce a firm policy for order size, charges, and terms.

Before implementing a pricing model change, give your customers a heads-up, so they aren’t surprised. Communicate with them about price changes and other policy changes in advance. If you keep them in the loop, you make them feel like more than just a number—and they’re more likely to stick with you.

Manage Flow to Mitigate the Risks Ahead

Interest rate increases, supply chain bottlenecks, supplier increases, inflation, and changing customer buying habits— businesses of all kinds are battling numerous headwinds. They each have their own effect on the cost of goods sold and your bottom line.

Sensitivity analyses and a hard look at billing practices and inventory can clarify how well a company can mitigate risk. Companies can increase their cash reserves and reduce their inventory to prepare for the lean times on the horizon. In addition, businesses can take other actions such as securing loans or credit now, while rates are still low; convert existing variable interest rate loans to a fixed rate as well, if that is an option.

The coming months will most likely be very challenging, there’s no getting around it. More rate increases are expected, and supplier prices will probably not stop climbing just yet. Businesses must prepare for expected and unexpected changes.

In times like these, it’s critical to have a reliable financial partner such as Bank of Blue Valley, to help you navigate future uncertainties. Reach out to the experts at Bank of Blue Valley today to plot your business’ course through the rest of 2022—and the years to come.

View the rest of the Series: Tactics to Tame the Cost of Goods Sold