Why official interest rates matter to small business

Australians pay a lot of attention to what the Reserve Bank of Australia does with official interest rates each month, and there’s a good reason for this.

Official interest rates have an impact on small business owners because they affect the cost of borrowing money and therefore the cost of doing business.

Interest rates affect the cost of borrowing money and therefore the cost of doing business.

Most businesses rely on some form of credit or loans to fund their business activities. Interest is the cost of borrowing money and the reward for lending it. You pay interest on money you borrow. You earn interest on money you invest.

What are interest rates?

An interest rate is the percentage rate charged on top of the loan amount. For example an annual interest rate of 2.5% means that you pay an extra $2.50 for every $100 borrowed. So if you had a $5000 loan at an annual interest rate of 2.5% you would pay $125 in interest every year.

When interest rates rise, the cost of borrowing money also rises. In the above example, a rise to 3% would mean you would pay $3.00 for every $100 borrowed.

Of course the opposite is also true, when interest rates go down the cost of borrowing is reduced, for example a drop to 2% would reduce interest payments to $2 for every $100 borrowed.

How do rates affect your business?

For small business owners, changes in the official interest rate impact on cash-flow. If rates rise, businesses need to find more money to make their repayments.

Lower interest rates make it more affordable to borrow money and small businesses can take advantage of low rates to pay down debts. When money is cheap it is a good time for businesses to borrow money to expand.

When interest rates rise it:

• Increases the cost of repayments on loans.
• Reduces disposable income for businesses.
• Increases the return on any invested funds.

When interests rates are lowered it:

• Reduces the cost of borrowing.
• Makes repayments more affordable.
• Creates more disposable income for businesses.

The more debt a business has, the greater the impact a change in interest rates has on them.

Different types of loans matter

The type of loan is also important. People with fixed rate loans will barely notice any changes to official rates, but those with variable rates will.

Fixed rates mean that the interest rate is set at a fixed rate for a predetermined length. This is great if the rate is low and interest rates are rising but not great if rates are going down.

The more debt a business has, the greater the impact a change in interest rates has on them.

Variable loans have interest rates that change in relation to the official rate. Borrowers with variable loans are exposed to interest rate rises but also benefit from any reductions over the term of their loan.

Small business owners should be aware of the impact of interest rate rises on their business. What impact will it have on your funding costs?  What impact will it have on your cash-flow and profit margin? Knowing the answer to these questions will help you prepare and plan for any future rises.