Bill Fink is executive vice president and head of U.S. commercial bank strategic partnerships at TD Bank. Views are the author’s own.
The Federal Reserve has increased interest rates ten times since March 2022. With an increase of 525 bps thus far, there has been near constant rate-hike anticipation. Despite Fed Chair Jerome Powell’s recent comments about continued rate increases to stifle inflation, CFOs are increasingly shifting their mindset toward ways to accelerate growth — both organically or through acquisitions.
While borrowing costs have increased dramatically in the past year, the opportunity to spur revenue growth that results in sustainable net profit improvement has risen on many CFOs’ priority lists. In this respect, CFOs need to be opportunistic with both the use of capital and debt. Here are three ways in which business can leverage the new rate environment:
1. Companies need to evaluate their capital investment plans. If a capital investment project can automate the business and reduce costs at a significant level, then it may make sense to move ahead with the initiative despite the current higher interest rates. The long-term benefits of reducing expenditures on a permanent basis through automation, whether through the use of robotics or other forms of technology, could provide a
positive discounted investment return including the short-term costs of higher interest rates. When rates do come down, CFOs can refinance the loan with their bank or undertake a high-yield bond placement, depending on the size of the capital investment initiative.
2. Evaluate opportunities for growth through mergers and acquisitions. While M&A activity has been reduced by increased interest rates and economic uncertainty,the M&A market is not closed and may present growth opportunities for CFOs. In the current market, bolt-on acquisitions are more likely to be available, as businesses seek to strengthen their existing platforms or open up new opportunities. However, potential buyers need to be cautious as the threat of a recession makes it difficult to determine the sustainability of earnings, revenue, and cash flow for the future.
3. CFOs should be assessing the potential and fostering organic growth. This could involve taking a new product deeper into an existing market or even expanding into a new market. If a business can identify an opportunity for organic growth that provides an economic benefit greater than its cost of capital, despite the increased costs of capital during the past year, then it may be worth pursuing.
I expect that interest rates will begin to decline in 2024 and continue into 2025. That means rates will still be elevated into 2025 — at least compared to where they were just a few years ago.
CFOs have to determine whether there are opportunities that advance the business strategically as well as for sustained revenue growth and profit. They have to balance the potential revenue upside from the new investment, with the (still elevated) cost of the capital--and not being overly bullish on the timeline of the return on revenue, which is easy to do.
The current rate environment will still present challenges for some businesses, but it also presents a range of new opportunities for others. By evaluating their capital investment plans, acquisitions, and initiatives for organic growth, companies can take advantage of the potential benefits. As businesses navigate this period of economic uncertainty, they will need to be strategic yet cautious — but the potential rewards for those who get it right can be significant.