How can SMEs manage higher interest rates?

Read time: 4 mins    |    Added date: 19/04/2024

With a global pandemic, cost-of-living crisis and a difficult labour market, the past few years have been particularly challenging for SMEs. The latest issue for many is dealing with the impact of higher interest rates. So, what can they do to cope and come out stronger? 

Managing higher interest rates and their impact on business as usual and long-term planning is challenging for many SMEs. After over a decade of ultra-low rates in the UK, adapting to the sharp increase from 0.25% to 5.25% has been tough. 

There is a glimmer of hope on the horizon though, with markets pricing in a likely interest rate cut in Q2 of 2024, although future changes in interest rates can be hard to accurately predict. 

What are the ramifications for small businesses? 

The immediate challenge of higher interest rates is the cost of servicing any debt held by SMEs. Taken in isolation, this has the potential to cause financial pressures. 

However, the higher cost of goods and services, recruiting and keeping staff, and the cost-of-living impact on consumer spending through fixed rate mortgages expiring have produced a perfect storm of challenges for SMEs to navigate. 

It’s doubtful there will be a return to sub 1% interest rates in the coming years. With low growth forecast for the UK economy, many SMEs are holding off investing in large capital projects until there’s more confidence in their sectors. The importance of detailed budgeting and planning is higher than ever. 

How are different sectors performing? 

It’s not been a level playing field surrounding the impact of higher interest rates on SMEs. For example, the construction sector has seen a reduction in demand as people have less money to spend, and new mortgage rates have risen. Other industries with tight profit margins have also been disproportionately affected, including some sub-sectors of retail and agriculture, as consumers have felt the pinch. 

Conversely, the software tech sector has generally managed to cope with the various pressures. In addition, SMEs that service a demographic with available cash (PDF, 1.52MB), such as bars and restaurants , have performed steadily as people prioritise what they’re spending their money on. 

Small or newer businesses have two main challenges. It’s generally harder for them to negotiate around prices, and they lack experience with budgeting, planning and implementing a risk management framework. 

Practical steps to help businesses cope

As part of helping business owners prepare for the future, James Miller, Head of Rates Sales - Small and Medium-Sized Business, Lloyds Bank, stresses communication is critically important. “SMEs need to make sure open dialogue with all stakeholders, including their customers and suppliers, not just their banks. It’s never more important when a business is managing a shock scenario.” 

From a financial perspective, one way Lloyds Bank can support SMEs is by making sure debt products are still the most appropriate for their needs so they’re not paying more interest than needed. It’s also worth exploring ways to switch to fixed price tariffs for things like energy and debt products, which make financial planning easier. 

A less obvious consideration is maximising the return on liquidity within businesses. As a result of higher interest rates, cash reserves currently held in standard accounts can generate better returns when moved to one with a superior rate or investing excess funds not needed for day-to-day operations.

“SMEs need to ensure that the lines of communication are open with all stakeholders, not just their banks. It’s never more important when a business is managing a shock scenario.”

James Miller Head of Rates Sales, SME Businesses, Lloyds Bank

Staying in control of cash flow and working capital 

“Cash flow is the lifeblood of SMEs but has been put under greater strain for many due to higher interest rates. Increased debt servicing costs are affecting the amount of cash available in businesses at a level many SMEs didn’t expect. Not many businesses are immune to the effects of higher interest rates, so keeping a tighter grip on credit control is vital”, says James. 

He’s seen many SMEs strive to become more efficient regarding working capital. This has involved adopting a new approach to stock management and renegotiating terms with creditors and debtors where possible. 

It’s also crucial for SMEs to consider the possible long-term continuation of higher interest rates and find the right balance between efficiency and the need to grow. As we strive towards a greener economy, there are many ways Lloyds Bank can help SMEs cut costs and prosper through products and services that support sustainability

James recommends focusing on the bigger picture, “What do higher interest rates mean for your customers and your staff? There’s a lot we can do to support clients who might be struggling, so we’d encourage SMEs to speak to us,” he affirms. 

What’s the outlook for 2024? 

The Organisation for Economic Co-operation and Development (OECD) forecasts UK GDP will grow by 0.7% in 2024.  This low growth will come with downsides and opportunities for SMEs.

One potential challenge is the ability of businesses to pass price increases onto consumers, which may become constrained as more people remortgage at higher interest rates. Also, with many SMEs leasing premises, rental and service costs will likely continue to rise. 

On the positive side, low growth may encourage the Bank of England to cut interest rates to stimulate the economy. Such periods, where many SMEs put a hold on expansion plans, can create opportunities for businesses willing and able to invest to get ahead of the competition. 


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