How Do Interest Rates Affect Businesses?

how do interest rates affect businesses

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Interest Rates Directly Affect Borrowing

Perhaps the most straightforward impact of interest rates on businesses is how rates influence business borrowing. Businesses often need to take out short term loans to to make up for shortfalls in payroll or other expenses, so higher interest rates make such shortfalls more costly, since the businesses will have to pay more interest back to lenders. Companies also frequently take out longer term debt for improvements and infrastructure. The higher the prevailing interest rates, the most costly taking on debt and therefore the less likely businesses will be able to commit the funds to such projects.

How Interest Rates Impact Buisiness Strategy

Another important impact interest rates have on businesses is in business strategy. At the most basic level, the goal of all businesses is to make profit. Therefore, venture a business makes must be thoroughly analyzed for its ultimate prospects at bringing in profit, and how those prospects compare to other possible sources of revenue. Since saving capital at current interest rates is a possible source of revenue, higher interest rates tend to make new ventures less attractive. For instance, if a cost benefit analysis shows that a new program within a company is likely

to yield a profit of 4% per year for all money put into the program, but the prevailing interest rates are 6%, the company is better off putting their money in the bank. In this way, interest rates dictate what a business will consider a strong return on investment.

Interest Rates and Investment

A third impact of interest rates on businesses is the their ability to raise capital through stock the value of stock prices. When a company goes public, it sells shares of the company in the form of stock to raise capital. Subsequently, the implied value of the business is tied to the share price of the stock, and share price is tied to demand for the company's stock. When interest rates are higher, the demand for investment tends to be lower, so higher interest rates are generally detrimental for company's stocks, and their ability to raise money through a stock offering. The reason higher interest rates are bad for stocks is that higher interest rates make traditional saving more attractive; if someone can earn a 5% guaranteed return by saving at a bank, they will be less likely to risk money investing, than if they could only earn 1 or 2% in a savings account.


Category: Personal Finance

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