Businesses have been warned to brace themselves for an increase in interest rates, with CBA predicting the first interest rate hike to be as early as June due to supply shocks caused by Russia’s invasion of Ukraine that is likely to push prices up.
Businesses have previously enjoyed record-low borrowing rates from traditional banks due to the all-time low cash rate and fierce competition from non-bank lenders, allowing them to fund their growth on the cheap.
However, inflation has accelerated faster than the RBA anticipated. The central forecast is for underlying inflation to rise further in the coming quarters to around 3¼ per cent before falling to around 2¾ per cent over 2023 as the supply-side problems are resolved and consumption patterns normalise.
The CPI inflation rate will rise above this due to higher petrol prices caused by global developments. The amount of time it takes to resolve supply chain disruptions and developments in global energy markets are significant sources of uncertainty in the inflation outlook.
So, what effect will higher interest rates have on businesses looking to finance their growth during an inflationary period with continued supply chain uncertainty?
With traditional bank lending requirements becoming stricter and more expensive, SMEs entering their next growth phase may find it difficult to access the same funds they could only 6-12 months ago.
As interest rates are expected to rise, Dynamic Business spoke with Joe Donnachie, Supply Chain Finance Manager at Octet, about the impact on lending terms, what this means for Australian SMEs looking to borrow to fund their growth, and how this may benefit the non-bank lending sector.
How do rising interest rates affect business?
“Most small businesses have outstanding loans in one form or another, and an increase in interest rates will essentially result in more expensive loan repayments for them. Since these are often long-term debts that will take years to repay, any increase in interest rates will mean carrying the debt for longer and incurring more interest.
“Increasing interest rates will mean higher repayments, less operating income, and higher overheads for businesses with company credit cards and existing loans.
“With the current crisis in Russia-Ukraine expected to send prices soaring, this will challenge the ability of central banks to keep inflation under control, pushing up costs for many businesses and forcing them to curb spending.”
What are the other alternatives to traditional bank lending? What impact will it have on the Australian fintech landscape?
“Beyond banks, there are other, more flexible sources of finance available to businesses. Debtor finance allows a business to access one of its biggest assets: its accounts receivables. A debtor (or invoice) finance facility can help bridge cash flow gaps by providing access to funds owed to your business when you need them.
“Rather than charging interest on a fixed loan amount, the finance provider instead charges a percentage of the amount owed in exchange for offering fast access to cash. This can be a good option for businesses that don’t have the physical assets to provide security to banks. They may have maxed out their property equity or have a business model that doesn’t require holding physical assets, such as eCommerce.
“Trade finance is a type of funding that provides you with a convenient, revolving line of credit to pay suppliers instantly to secure better repayment terms. While it’s often used to streamline international trade, it can also help Australian businesses strengthen relationships with local suppliers who may have short payment terms or require full payment upfront.
“And much like debtor finance, it doesn’t require businesses to provide physical assets as security, instead of balance sheet strength is the key assessment criteria. These finance types are both variants of Supply Chain Finance, which links suppliers and buyers in one process and uses off-balance-sheet funding to improve cash flow.
“You can think of it like any other form of credit, such as a business credit card, except it offers many additional advantages that are all geared towards accelerating the cash flow cycle and improving key trading relationships.”
How can small businesses deal with rising interest rates? What effect will it have on businesses that will be forced to use their cash reserves?
“With traditional bank lending requirements becoming stricter and more expensive, it may be difficult for SMEs entering their next growth phase to access the same funds they would have been able to only 6-12 months ago.
“This may be an issue for companies that want to secure funding to finance expansion, pay suppliers in advance, pay staff, or cover other costs. This could lead to a company falling behind competitors because they don’t have the available working capital to stay flexible and adapt to the market.
“For SMEs on the smaller side, this can have a serious knock-on impact, and many may have to put up physical assets, such as their property, to secure a loan. That’s where non-bank lending solutions such as Supply Chain Finance can help to cover the cash-flow gap.”
How can a company keep its cash flow healthy?
“Supply Chain Finance offers great tools for managing cash flow. Debtor finance allows companies to claim cash early from their receivables. In contrast, trade finance can enable companies to pay suppliers early to speed up supply without necessarily having the cash reserves available at the time of purchase.
“Paying for goods upfront can improve relationships with suppliers, which is critical to navigating challenging times. Crucially, an effective customer-supplier relationship also opens opportunities for early payment discounts.”
“Paying early can often help your suppliers with their financing. If the timing is managed well, your suppliers can reduce their need for funding, use their improved cash flow to grow their business or pass the liquidity onto their suppliers. In a rate rise, this can be a huge advantage and can help you build valuable goodwill.
“Of course, being able to negotiate an early payment discount for your own business will help the bottom line in the long term, but cash flow may suffer. So, using trade finance can be a great way to gain advantages without compromising cash flow.
“To secure an early payment discount, it’s important to approach suitable suppliers. These are firms that are either critical to your supply chain, are suffering a cash flow squeeze themselves (or are suffering from high local interest rates) or if you suspect other customers are serving their extended payment terms.”
Ukraine war to intensify supply chain woes
The persistence of supply-side shocks from the COVID pandemic, the extent to which “developments in Ukraine add to these supply-side inflation pressures,” and the evolution of labour costs in Australia are the primary reasons that could prompt the bank to move earlier
The RBA governor, Philip Lowe, said this week at an Australian Financial Review summit that Australia’s economy was relatively well-positioned to weather the war-related supply disruptions because the country exports “many of the commodities whose prices are rising.
“Despite financial markets and some economists predicting that the RBA will raise cash interest rates from a record low of 0.1 per cent as soon as July, if not sooner, Lowe reiterated that the bank was not in a rush to act.
“The recent increase in inflation has brought us closer to the point where inflation can be maintained within the target range,” he said. “Recent global events have done the same. But we’re not quite there yet.”
With wages picking up, “it is plausible that the cash rate will be increased later this year”, he said, adding that the invasion of Ukraine had added to uncertainties.
Here’s a quick guide to approaching the supplier.
Click here for a Statement by Philip Lowe on RBA’s Monetary policy decision