{"id":7604,"date":"2023-04-12T17:25:50","date_gmt":"2023-04-12T17:25:50","guid":{"rendered":"https:\/\/intelekbusinessvaluations.com\/en-au\/?p=7604"},"modified":"2023-04-17T14:12:05","modified_gmt":"2023-04-17T14:12:05","slug":"how-higher-interest-rates-have-impacted-your-business-value","status":"publish","type":"post","link":"https:\/\/intelekbusinessvaluations.com\/en-au\/business-valuations\/how-higher-interest-rates-have-impacted-your-business-value\/","title":{"rendered":"How Higher Interest Rates Have Impacted Your Business\u2019 Value"},"content":{"rendered":"

Although interest rate hikes have been meant to counter historical highs of inflation, they are not free of consequences to the economy or businesses. Such consequences have been significant headlines in recent weeks e.g., the 2nd<\/sup> largest collapse of a bank since 2001, SVB, along with the collapse of other regional banks. The U.S. Federal Reserve Bank (the \u201cFed\u201d) interest rate hikes affect the required rate of return from investors (or discount rate) by increasing a key component of its calculation; this in turn affects the calculation of business values.\u00a0 In this article, we will explain the impacts interest rate hikes have on businesses and their valuations.<\/p>\n

The Fed\u2019s countermeasure for the historically high inflationary environment has resulted in continual increases of interest rates since March 17, 2022, with its latest rate hike being on March 2, 2023. The total increase of the Fed\u2019s fund rate from Feb 2022 to Feb 2023 has been 449 bp, sitting, from 4.75% to 5.00%, and taking the Fed\u2019s Funds Rate back to pre-2008 financial crisis levels.<\/p>\n

\"Historical-feds-funds-rate\"<\/p>\n

Note: Board of Governors of the Federal Reserve System (US), Federal Funds Effective Rate [FEDFUNDS], retrieved from FRED, Federal Reserve Bank of St. Louis; https:\/\/fred.stlouisfed.org\/series\/FEDFUNDS, April 4, 2023.<\/p>\n

How Interest Rate Hikes Impact Businesses<\/strong><\/h2>\n

Interest rates hikes have direct and indirect impacts on the operations of a business including, but not limited to:<\/p>\n

Consumer Demand for Goods and Services Lowers<\/strong><\/p>\n

On a consumer basis, demand for goods and services is negatively impacted. Interest rate hikes may decrease consumption as credit card rates are higher, opportunity costs of consumption in the present also increase as savings rates are more attractive. Another impact on consumer demand for goods and services is the reduction of disposable income due to the periodic increase in monthly mortgage expenses on adjustable-rate mortgages.<\/p>\n

Higher Cost to Service Debt<\/strong><\/p>\n

As interest rates rise, the businesses\u2019 interest expense to service debt increases. Some businesses might be running on limited margins or situations where the rise in interest expense can cripple the company. As a result, a business will rethink taking on any new debt or might look for cuts in expenses. If businesses are fortunate enough to have strong demand, they may be able to pass some or all of this on to the consumers.<\/p>\n

Slower Growth<\/strong><\/p>\n

Due to higher costs to access loans, businesses will attain slower growth. Funding is key for many businesses to cover working capital or capital expenditure requirements when looking to grow or expand their operations. As a result of higher costs to service debt and uncertainty due to high inflation and interest rates, businesses choose to step back on growth or expansion opportunities.<\/p>\n

Lower Investment and Businesses Demand for Goods and Services<\/strong><\/p>\n

As a result of lower consumer demand, businesses stepping back due to higher costs of debt and economic uncertainty, businesses\u2019 demand for capital goods can decline as their income declines, and they choose to be conservative out of fear of a potential recession.<\/p>\n

Rise of Unemployment<\/strong><\/p>\n

Considering all the impacts herein mentioned such as lower consumer disposable income, higher cost to service loans, and restricted investments under a period of uncertainty, companies might take the decision to lay off workers.<\/p>\n

In summary, the potential consequences of high interest rates for a business are numerous and vary degrading for a country\u2019s economy. However, not all businesses are affected in the same way, and for some, the consequences above are a combination of several factors which may not impact certain industries or companies that heavily; e.g., companies with a good stream of cash flows, sectors with low requirement for debt or with less sensitivity to the economic conditions based on the type of goods or services provided.<\/p>\n

How High Interest Rates Impact Business Valuations<\/strong><\/h2>\n

Nevertheless, even if a business is not materially impacted by any of these factors and can continue its operations as usual under a high inflationary environment and several interest rate hikes, its valuation can be affected because of the required rate of return or discount rate from investors. This is due to different components in the building of a discount rate or required rate of return such as:<\/p>\n