HeartBeat Summer 2018 | Page 12

INTEREST INSIGHT Fixed Interest Rates; Right for my Situation? Jeff Houts, Executive VP, COO Recent activity by the Federal Reserve has been driving an increase in short-term interest rates. Since the middle of 2016, long-term interest rates have also trended higher. FCS Financial offers a wide choice of interest rate programs from short-term variable to long-term fixed. With so many choices, what factors should be considered in making a decision to use a fixed interest rate loan product? I believe choosing your loan interest rate program should be put into the context of your unique financial and operating situation. Agriculture is a diverse industry with many different variables. Often, broad statements and generalizations just don’t apply. To step away from generalizations around choosing whether a fixed rate product is right for you, considering some questions in specific areas has been helpful to me in reaching a thoughtful decision. Consider your balance sheet. How much total debt is present? 12 HEARTBEAT | SUMMER 2018 More debt increases potential risk associated with interest rate upswings. What is the value of your cash or near cash assets compared to your short-term obligations – the amount you have to pay during the current operating cycle of your business? Liquidity is the ability to pay short-term obligations. Decreased liquidity occurs when the value of your cash assets subtracted from your short-term obligations is low. The less liquidity present in a balance sheet the lower the ability to take on additional risk or operate through adversity without special action to increase liquidity. When total liabilities are higher and liquidity is lower, fixed interest rates should be considered to limit the additional pressure on liquidity which increasing interest cost will bring. Think about your cash flow. How much positive margin is present? How material on a percentage basis is total interest expense in relation to income and profit margin? How much would a 1 percent increase in interest impact the profit margin? If a modest increase in interest rate materially impacts income and ultimately profitability, then fixing interest cost is a risk limiting tool which should be considered. Where in the life cycle is the business? Growing a business many times means using debt capital to supplement owner’s equity in supporting that growth. Typically, that means there will be debt outstanding over a number of years. Duration of the time there will be a loan balance outstanding is an important factor to weigh as you make a decision whether to lock in a fixed interest rate. If you expect to be growing the business scale and using debt capital to support growth, using some longer term fixed interest debt can be valuable in limiting overall interest rate uncertainty. Additionally, a loan duration of more than 15 years regardless of growth plans has a substantial life cycle for market changes to interest rates. If interest rates are historically low in the cycle, trends are moving higher and duration for the debt is long term, fixed rates should be a consideration for limiting future risk of increased cost which negatively impact profit margins. Compare historical interest rate trends to what is being offered today. Are there signals present in the market place telling you about the future cost of interest? INTEREST: Continued on pg. 22.