Everyone is feeling the effects of rising interest rates and inflation, whether it’s visiting the grocery store, eating at a restaurant or planning a home improvement project. High interest rates can have an impact on a company’s value, and also affect its operations, financial health and overall success. Knowing how inflation affects businesses and how to prepare and adapt your business to inflationary trends can be a major benefit. Using these four smart business strategies for managing inflation can help a business not only weather inflation but come through it stronger.
Key Takeaways:
- Almost two decades of historically low interest rates lulled many into a false sense of security, necessitating a complete shift in business strategies
- Mitigating the negative effects of a high interest rate environment is a must to protect your business’ value
- Inflation impacts may areas of a business, including cost of components, increased required rate of return for investors and more limited options for growth, making it imperative for leaders to make necessary adjustments to adapt
- Business owners should consider a wide range of strategies to combat the effects of high inflation and interest rates, including reducing debt levels and diversifying funding sources
Record Low Interest Rates Are a Thing of the Past
The period between 2008 and 2021 was characterized by historically low inflation. This record-long period of low inflation and low interest rates led some to believe that inflation could be kept at low levels indefinitely. However, since early 2021, the rate of inflation has increased dramatically at a pace not seen since the early 1980s. Inflation and interest rates generally move in tandem as short-term interest rates are used by the Federal Reserve to counteract rising inflation.
The way inflation affects an individual business depends on its unique economic circumstances: what industry it’s in, how its particular costs are rising or falling, the productivity of its workforce, the nature of its supply chain, the level and type of its debt and so on. Companies with pricing power or low commodity inputs can often pass the higher costs on to customers, offsetting some of the negative impacts of high inflation and interest rates. Understanding how high interest rates may impact the value of your company is key for business owners.
How Does Inflation Affect Business Value?
While inflation and interest rates do not impact all businesses equally, high inflation and high interest rates can negatively impact the value of a business in several ways:
Increased Cost of Borrowing
Companies that rely on debt to finance their operations will face higher interest expenses, which can eat into profits and reduce cash flow. This, in turn, can lead to a lower valuation as investors may be less willing to invest in a company that is facing challenges in managing its debt.
Increased Required Rate of Return for Investors
The required rate of return, the minimum rate of return required by an investor to invest in a particular business, plays a critical role in determining the value of a business. The required rate of return reflects the time value of money and the perceived risk associated with an investment.
As interest rates rise, the required rate of return by investors also generally increases, making it more expensive for businesses to raise capital. This impacts the value of future cash flows and, ultimately, the value of the business. It may also make it more expensive for a potential acquirer to buy the business.
Reduced Customer Demand
Another way that high interest rates can impact business value is through the effect on customer demand. When interest rates are high, consumers may be less likely to borrow money to purchase goods and services, as the cost of borrowing becomes more expensive. Depending on the business’ industry, this can lead to lower sales, which can have a negative impact on overall business value.
Reduced Ability to Invest in Growth
High interest rates can impact a company’s ability to invest in growth and innovation. When money is more expensive, companies may be less willing or able to invest in new products, technologies or expansion plans. This can limit the ability to compete in the market, potentially leading to a decrease in overall business value.
4 Smart Business Strategies for Dealing with Inflation
Despite the challenge posed to business owners by the rising interest rate and high inflation environment, there are opportunities for businesses to maintain or even increase their value. Taking swift, decisive action to reduce costs and improve your standing with investors can help ensure your business not only survives these challenging times but gives it a chance to thrive.
Reduce Debt Levels
By paying off debt and avoiding new debt, companies can reduce their interest expenses and improve their financial health. This can make them more attractive to investors, making it easier to increase or maintain value in the business.
Diversify Funding Sources
Rather than relying solely on debt financing, businesses can explore alternative funding sources such as equity financing or partnerships. This can reduce the reliance on borrowing and can help to mitigate the impact of high interest rates on the business’ financial health and value.
Improve Operations and Efficiency
By reducing costs and increasing productivity, companies can improve their profitability and cash flow, which can help to offset the impact of high interest rates. This can also make the business more attractive to investors and can help to maintain or increase its value over time.
Invest Excess Cash into Growth
If the business has a large amount of cash not being utilized in its operations, it can consider investing the cash in the growth of the company. This could take many forms, including adding additional talent to the roster or expanding the number of services or products offered. Retaining or even acquiring new customers can ensure a consistent cash flow, as long as you offer a service or product they value.
High inflation and interest rates can impact a business’s value, but proper preparation and a keen sense for when to adjust your business strategies can help protect your company’s value, even in a challenging economic environment.
Anders Valuation group works with companies and provides credible, cost-effective and pragmatic valuations with a combination of financial analysis and professional judgment. Learn more about the variety of valuation services our advisors routinely provide, along with the associated fees, by contacting Anders below.
