Combating higher interest challenges and its consequences (and what can be done about it)
Things are never certain and what is certain is not always sustainable. This is the reality of the business world today, in particular if you look at the behavior of interest rate today. Not too long ago, we were told about potential US interest rate cuts but………The Federal Reserve of US has most recently hold interest rate cut steady in the midst of stubborn inflationary pressures.
Now, this is a big deal and can mean very devastating effects on your business.
With high interest rate being maintained, businesses that are already holding on massive debts will find it extremely challenging to service it especially given the current lackluster business environment. And for some, they just cannot keep borrowing to sustain or expand their business.
What we are observing and seeing today is massive cost restructuring through cancel business activities, layoffs and closures. Risk is high and uncertainty is looming.?
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To manage the challenges from high (or higher) interest rate, you need to take a multifaceted approach and look at it from a few angles to have a more comprehensive perspective on its potential risk and opportunities. Here are just a few key aspects that can be very useful to you.
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?1.???? Cash flows to service debt
If your business has the ability to generate cashflow from your business activities that allows you to service your debts obligation as and when it falls due, obviously you are in a much safer position. Hence from a business standpoint it is extremely important to review a few things:
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·?????? Your product and/or services portfolio. Do you have a good mix that allows to better generate cashflows?
·?????? Your working capital management. Is your cash conversion cycle working to your favor?
·?????? Your supply chain or services platform. Do you have any alternatives that allows you better collaboration power?
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?2.??? Interest Coverage Ratio
The interest coverage ratio is a debt and profitability ratio that shows how easily your company can pay interest on its outstanding debt. It is calculated by dividing your company's earnings before interest and taxes (EBIT) by its interest expense during a given period.
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The higher the ratio is, the stronger is your company to service the interest. You must always track on this ratio on both current and on a projection basis.
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?3.??? Debt-to-Equity Ratio
A debt-to-equity (D/E) ratio is a financial metric that compares your company's debt to its equity. It's used to assess a company's financial health and how much debt it uses to finance its operations.
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The higher the debt your company undertakes, the higher this ratio will be. If unchecked over time it will not be a healthy sign especially if you also have a low Interest Coverage Ratio.
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4.??? Sustainable growth rate
It is important to conduct a financial sustainable growth analysis to gauge how far your business can go without external funding. Sustainable growth analysis shows the maximum pace at which your business can grow by maintaining its current capital structure, without new loans and without issuing new shares for new investment.?
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Use this sustainable growth analysis wisely to determine any need for additional debts, both for the short-term and long-term.
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Finally, high interest rate makes managing business debts an even more crucial part of a key responsibility in any business. Presently mounting unsettled corporate debts are building up in many businesses’ balance sheets. This is a clear sign of danger that cannot be ignored or put on a lesser level of importance.
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