Companies have been working on their 2023 business plans and budgets since the beginning of fall 2022. During this time, numerous developments have occurred in the economy and financial markets. One of the biggest concerns is rising interest rates around the world and how long they may remain elevated.
For the U.S Federal Reserve, the interest rate is expected to rise to 5.25-5.5% in 2023 and maintain that level until inflation is under control. Other central banks are taking similar actions around the globe. A U.S recession is expected in 2023, but its length and depth are uncertain.
Terminal interest rates will probably be held beyond 2023 and into 2024 – and perhaps even into 2025. Given the degree of uncertainty and global market risk, companies face numerous scenarios for which they must be prepared.
How Interest Rates Affect a Business
A key question for planning professionals is “How will interest rates affect my customers, my business, and my business operations?” Interest rate levels and changes can have both direct and indirect effects on a business and its customers.
1. They can affect the interest expense for financing working capital, such as inventory.
2. They can affect the financing cost of capital goods and capital projects.
3. They can affect the interest expense of rolling over debt when maturity has been reached.
4. They can affect the company’s cost of capital through interest expense directly and through investor expectation for equity returns as interest rates rise or fall.
5. They can affect the ROI hurdle rates used in making capital investment decisions and in product development projects.
6. They can affect the currency exchange rates faced by the company when buying and selling goods as well as those faced by the company’s customers.
7. They can affect the overall capital structure of the company through the relative proportion of debt financing and equity financing.
8. They can affect the interest costs for customers purchasing the company’s products, especially inventory and “big ticket” items like cars, trucks, and other capital assets.
So, interest rates and their effects are important considerations in many business scenarios for demand planning and Financial Planning & Analysis (FP&A) purposes.
Re-Evaluate Your 2023 Financial & Operating Plans
Any “approved” 2023 business plans, demand plans, budgets, and financial plans should be re-evaluated, and stress-tested to reflect how interest rate changes will affect the business and its customers. They may already be out of date.
Any adjustments to operational and financial plans should be made before implementing the financial reporting processes for 2023 to ensure that business metrics are utilizing a realistic set of goals, benchmarks, and budgets throughout the company. These should be periodically reviewed during the 2023 financial year. 2023 will be a time of changing business and market dynamics.
Interest Rates & Requests for Investment
When making requests for investment in product development, capital investments or new software, for example, it is important to consider the effect of changing ROI hurdle rates as interest rates change. The foundation of these ROI hurdle rates is the company’s cost of capital – debt and equity. The increase in interest rates into 2023 will have an associated effect increasing the investment ROI hurdle rates for the company so the justification for investments will require greater financial benefits. (ROI hurdle rates are also adjusted to reflect the degree of financial risk in investment types and so are modulated up and down to reflect this consideration.)
When requesting resources during 2023, it is important to work with the FP&A function to ensure that the request can be structured to meet the level of performance necessary to make the investment financially successful for the company.
2023 is upon us. It is essential that we be analytical and adaptive if we are to choose the best path towards operational and financial success. Understanding the impacts of interest rates is an important part of this effort.
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