Inflation and Interest Rate Increases are Affecting Small Businesses

The Federal Reserve stated earlier this month in its Federal Open Market Committee (FOMC) statement that inflation remains “elevated, reflecting supply and demand imbalances associated with the pandemic, increased energy costs, and broader pricing pressures.”

Russia’s invasion of Ukraine is wreaking havoc on the country’s people and economy, but the repercussions for the US economy are unclear. According to the FOMC statement, the invasion and associated events are anticipated to put significant upward pressure on inflation and impact economic activity in the short term.

Recent Data Suggests Small Business Owners are Concerned about Inflation

inflation chart

According to a recent poll performed by the US Chamber of Commerce, the number one concern of small company owners is inflation. According to the report, 67 percent of small firms have boosted their pricing to combat inflation. Another four in ten (41%) report having reduced personnel or taking out a loan in the previous year (39%) in response to rising inflationary pressures.

“After surviving the epidemic, small company owners are now confronted with skyrocketing inflation.” It reduces their purchasing power and forces small firms to raise their own pricing and endure higher costs within already low margins,” said Neil Bradley, chief policy officer of the United States Chamber of Commerce. Material, inventory, labor, and gasoline costs continue to climb, putting pressure on even the most lucrative enterprises.

“Despite today’s higher unemployment rate, there are much more job vacancies today than before the outbreak,” stated Fed Chair Pro Tempore Jerome H. Powell. “Every month, a record number of people left their employment, usually to take a better-paying position.” Nominal salaries are growing at the quickest rate in decades, with people at the bottom of the income distribution benefiting the most. Workers at the lowest end of the pay distribution are frequently employed at the smallest mom-and-pop shops. As a result, wage inflation is having a considerable impact on the tiniest of small enterprises.

Furthermore, Powell highlighted that inflation rose substantially in the autumn and that the median forecast for year-end 2022 has risen from 2.6 percent to 4.3 percent since the FOMC’s December meeting.

“In my opinion… forecasts vastly overestimated the severity and durability of supply-side frictions, which, when paired with robust demand, particularly for durable goods, caused surprise high inflation,” Powell stated following the FOMC announcement.

The Fed’s long-term goal is to attain maximum employment and a 2% inflation rate. As a result, the FOMC agreed to raise the federal funds rate target range to 1/4 to 1/2 percent and thinks that future increases will be appropriate. The Committee will continue to assess the effects of COVID on public health, labor market circumstances, inflation pressures, and financial and international events.

The necessity for consistent and continuous funding is something that business owners will have to deal with for the foreseeable future. The current rising inflationary and higher interest rate environment presents a problem for small company owners. Costs continue to rise as a result of persistent supply chain difficulties and workforce constraints.

Rate rises by the Fed will raise the cost of borrowing for small firms. These rates are already far higher than the benchmark rate for mortgage financing, for example. This might result in a minimum borrowing cost of roughly 9% APR. Because most business lenders provide floating or variable rate financing products, the increased rates will apply to current loans as well as new loans created this year.

As interest rates rise, the cost of SBA products will climb as well. Even if small business owners do not intend to expand anytime soon, they should be ahead of the game by applying for a financing option now rather than later.

Women entrepreneurs, in particular, should keep a careful eye on these economic developments. Biz2Credit issued its annual Women’s Small Business Study earlier this month. It discovered that sales of female-owned businesses fell 26 percent in 2021 compared to 2020, and credit ratings also fell. Lower credit ratings might make it difficult to obtain the best interest rates.

In the future, company owners should bear in mind that most small business loans and SBA products are granted at floating rates since the Fed has indicated a readiness to continue raising rates. They must consider the rising cost of capital while making decisions.

While interest rate spreads can range from the mid to high single digits to the double digits, rates may not be the decisive factor. Instead, for certain businesses, the most essential consideration is frequently immediate necessity, which includes the opportunity cost of missing out on a property or obtaining products at a fair price through early payment. This is becoming increasingly crucial at a time when supply chain challenges are driving up raw material and finished goods costs.

Since the middle of last year, many finance professionals have been aware of a shift in the interest rate environment. Borrowing rates were near zero for many years, and low-cost money flowed to businesses for a long time. There hasn’t been a big rate rise trend since 2018, a pre-pandemic period that feels like an eternity ago. If small firms can receive fixed-rate financing now, they should take advantage of it since rates are anticipated to rise more as the Fed implements measures targeted at lowering inflation.

Adam Torkildson
Adam is a proud American citizen, entrepreneur, 2x founder, father of 2, and married. He considers himself a Constitutional Conservative and loves to golf and read books when he's not running his businesses and writing content.