Inflation, fluctuating gas prices and ongoing supply shortages have the Federal Reserve raising interest rates recently. Many business owners are thinking about how to offset the cost of borrowing capital for their business. How exactly does that affect day-to-day operations with your franchise?
How interest rates affect economic activity, why they change, and how they can affect your franchise are things all good entrepreneurs should consider.
Who Decides Interest Rates?
In the US, the Federal Reserve (the Fed) meets eight times each year to set its target interest rate. Every meeting doesn’t always result in a rate change, but banks and business owners anticipate each meeting to see what the Fed will do.
Fed interest rates have been as low as 0.25% (in response to the Great Recession and the COVID pandemic) and as high as 20% (in response to runaway inflation in 1980). The average historical interest rate has been about 5.4%.
Of course, the Fed interest rates represent only a minimum value. In reality, franchise owners might see a variety of interest rates, from less than 1% for savings accounts to as high as 25% or more for some credit cards. And something like a mortgage or small business loan will fall somewhere in between.
Why Does the Fed Raise Interest Rates?
If low-interest rates are a good thing, why would the Fed want to raise them? The main reason interest rates are raised is to control inflation and keep the economy from overheating.
Here’s how it works: When interest rates are low, more people can afford to borrow money for cars, vacation homes, and credit card purchases. That’s great for the economy and even your franchise. For example, if you run an insurance franchise, you’ll enjoy the benefits of more people needing auto insurance for their new cars and home insurance for their new homes.
Eventually, so much demand will outstrip supply and prices are bound to go up everywhere. Soon, your hard-working employees need a raise to keep up with higher prices. To keep up with higher payroll expenses, you might raise your prices even more. Imagine the same situation happening with housing and groceries, and you now have an idea of how inflation works.
When wages can’t keep up with inflation, people start falling behind on their mortgage payments, people aren’t buying new cars and franchise owners can’t afford to hire more staff.
This is why raising interest rates can help the economy. When interest rates increase, borrowing money becomes more expensive for everyone. People will spend less on vacations and other luxuries like eating out. In response, franchise owners like yourself can start charging less to attract more business.
High-interest rates are supposed to be a temporary measure because overdoing it can make demand fall too low, leading to a recession. So, the Fed is constantly monitoring the health of the economy and adjusting interest rates to get the balance right.
How Can Interest Rates Affect Your Franchise?
Interest rates and small business are closely linked, and franchises are affected in three major ways:
- The Cost of Borrowing Money
- Your Bank Account
- The Relationship with Your Employees
Let’s explore each of these in more detail.
1. The Cost of Borrowing Money
This is the most immediate effect of interest rates on borrowed money, such as from business loans or lines of credit. While changes in interest rates seem small, they can really add up over time.
For instance, let’s suppose you wanted to finance an M&A with a bank loan of $100,000, to be paid over 10 years. In 2015, when rates were as low as 0.25%, the total cost of that loan would be just over $101,250. That same loan in late 2022, with interest rates at 3.75%, would cost you almost $120,100. That translates to paying almost 19% more on your monthly loan repayments.
Keep in mind that this is just an example case. In reality, banks rarely extend loans at the Fed’s interest rate because they have to make money, too.
When franchises and other businesses pay more for loans, they’re more likely to reconsider whether the loan makes financial sense, especially if they feel that it’s better to hold off until interest rates come down. That could be bad news if you’re trying to sell your business.
2. Your Bank Account
The good news is that higher interest rates aren’t all bad news. In fact, when interest rates rise, you’re likely to see your savings account grow. After all, when you put money in a savings account, you’re essentially allowing the bank to borrow your money in exchange for some interest payments. Other interest business accounts like money market and high-yield checking accounts benefit from higher interest rates, too.
It may not be much, but seeing your savings grow more is one way to soften the impact of higher interest rates.
3. The Relationship with Your Employees
Being a great workplace leader is always a balancing act, especially when it comes to payroll and hiring. When business is good but interest rates are high, it’s only natural for your employees to ask for raises — after all, they’re paying more for their auto loans, mortgages, and other goods. But if you raise wages too much, you may not be able to make your own loan payments and other business expenses.
On the other hand, when the economy is slow, should you try to keep your existing staff? Or should you lay off part of the team and take advantage of a low-interest business loan to make those needed building repairs?
It’s a tough choice, and the best answer will depend on the specific circumstances of your franchise. But remember that banks are always willing to lend you money, while experienced, highly motivated employees are worth their weight in gold.
People Always Matter More than Interest Rates to Your Franchise
It’s easy to get caught up in making the best financial decisions based on interest rates, but the best investment your franchise can make is by investing in its people. At Confie, we put people and culture above everything. Get in touch with us today to learn more about our franchise opportunities or give us a call at (714) 252-2500.