At the time of writing this as a first draft, Janet Yellen, Chair of the US Federal Reserve “oversight committee” (FOMC) was testifying to Congress on the economic outlook, and it has since been a hot topic of conversation. As part of her mandate she has to testify regularly but why is this particularly important now?

The big question in the City of London and on Wall Street is when are interest rates going to increase and move towards levels not seen since the financial crisis of 2008?

The key central banks of the US, UK and Europe collaborate and it is the US which tends to take the lead.  So if the US increases rates, we can be sure the Bank of England and European Central Bank will not be far behind.

Many are speaking of a mild increase in December and perhaps two or three further increases in 2017.  Others have a different view!  Unless you are on the inside of these institutions it is foolish to predict what will happen and when.  However, I will put my neck on the block and say, increases will come by the end 2017, and as business managers, we need to be clear of the impact and implications.

So how will this normalisation of interest rates (from an unprecedented 10 years of stagnation) affect our business activities?

Principally, when rates rise, banks charge more for business loans, thereby decreasing profits (all else being equal).  In such circumstances, typically, small businesses defer new projects or initiatives placing a constraint on business improvement and growth.  I am afraid to say it has not been advised to such businesses: never (ever) use debt for sales, marketing, growth and entrepreneurial initiatives.  Debt should only be used to fund stable, predictable, low-risk assets and operations.  Reserves, retained earnings and external equity investment should be used to fund top-line expansion projects where the risk is higher but the returns greater for the equity investor.

Furthermore, some of your commercial customers will experience a cash flow impact if they have debt and may delay payments and progression of new projects/initiatives.  An emphasis needs to be placed on managing the cash flow cycle and on securing further business through a clear understanding of the benefits and upside.

If you think you may need to arrange lending in the next few months for the right reasons, consider getting the wheels in motion now or finalise a deal you may have been considering.

Debt has a bad name but in a business sense, if we are using it in the correct manner i.e. supported by stable cash flows from the business, it has other surprising effects.  While the immediate impact is a hit on profits, for limited liability companies, it reduces the amount of profit from a company that is taxed.  Provided there is a meaningful difference between the interest rate and tax rate, debt actually creates a greater return for the equity investor, the owner manager, and any other key individuals.  Used wisely, lending has many important benefits.  For anything else, dip into those reserves and pretend you’re an outside investor – what return do you need to keep you happy.

Want to talk to someone about your business’ financial situation and strategy in more detail? Head over to the A4G Growth website and pop your details in the contact form and one of the team will give you a call.