How do rising interest rates affect accounting?

In July of this year, the US Federal Reserve raised interest rates to a 22-year high to fight against spiraling inflation. The theory is that when rates are increased, people save more, and this decreased demand for goods and services leads to lower prices. We’ll believe it when we see it...

But this isn’t another consumer-focused article on interest rates. As a company in the accounts payable (AP) automation space, we want to talk about what rising interest rates mean for AP teams, like yours. What actions should you take in response to them? Will they leave your balance sheet imbalanced? What implications do they have for assets and liabilities?

In an economy where rising interest rates reign, it’s important to understand their impact. And that’s exactly what this article will explore. We’ll also share insight into how AP automation can help your business better manage this challenge.

What happens when interest rates rise?

As a consumer, you’re familiar with the impact of higher interest rates. Often, the biggest challenge they create for us is making money more expensive to borrow. Financing major purchases like cars or houses can be difficult or even impossible, depending on the rate of interest attached to the loan.

Accounts payable professionals must also respond to the challenge of increased borrowing costs. If your business uses short-term loans or lines of credit to manage cash flow and finance operations, then higher interest rates make this more expensive. And it’s likely that you do to some extent. According to Equifax, the first quarter of this year saw a 15% increase in business credit card balances compared to last year, and other lines of credit increased by 11%.

To prevent rising interest rates from impacting your company’s cash flow, there are several actions accounts payable teams can take:

• Negotiate favorable payment terms – when facing higher borrowing costs, you’ll want to get more out of the money you have. Negotiating better terms with vendors and suppliers — such as extending payment periods or exploring early payment discounts — is a good step toward achieving this.
• Review existing contracts to avoid penalties – you should evaluate your current contracts to identify any interest rate-related clauses or delayed payment penalties. If you deem the penalties infeasible, you may want to switch suppliers, or prioritize making those payments earlier.
• Schedule payments strategically – through smarter payment scheduling — such as making payments earlier to avoid penalties or delaying payments where penalties don’t apply — you can ensure your business has sufficient liquidity to cover its obligations, without needing to borrow cash.
• Monitor currency exchange rates – if your business operates internationally, rising interest rates can affect exchange rates, which can then increase the cost of imported goods and services. So, you’ll want to regularly monitor exchange rates.
• Communicate frequently with vendors – maintaining strong vendor relationships is key. You should communicate openly on payment expectations and be upfront about changes in your payment schedule. This can help you avoid potential conflicts, such as a vendor freezing its services and leaving your business in the lurch.

These strategies can help you to operate smarter during this high interest period. However, rising interest rates will always impact on your business in some way, so you need to know how to account for them. Let’s look at how they influence your balance sheet.

The impact of rising interest rates on your balance sheet

It’s hard not to be all doom and gloom when talking about rising interest rates. However, there are two sides to every coin, and we want to have a balanced view (puns intended).

Let’s look at how interest rates impact each side of your balance sheet. In other words, the assets and the liabilities.

The assets:

• Cash and cash equivalents – rising interest rates can lead to higher yields on cash equivalents, such as short-term investments or money market funds. This can generate increased interest income for your company, and this should be recorded as an asset on the balance sheet.
• Investments – if your business has investments in fixed-income securities, such as bonds or certificates of deposit, higher interest rates can lead to a rise in the market value of these investments. This increase in the fair market value of investments represents an increase in the asset value on your balance sheet.
• Accounts receivable – just as rising interest rates impact your payment practices; they can also affect your customers’ payment behavior. If interest rates rise and customers struggle to make payments, your accounts receivable balance might increase. This is listed as an asset on the balance sheet.

The liabilities:

• Short-term debt – your company may have a variable-rate short-term debt, such as a revolving credit facility or commercial paper. Higher interest rates increase the interest expenses on these debts, and this should be reflected in your liabilities.
• Long-term debt – if your business has variable-rate long-term debt, rising interest rates will also lead to higher interest expenses. The portion of long-term debt due within the next year must be recorded as a current liability.
• Accounts payable – we previously mentioned the benefit of negotiating new payment terms with suppliers due to the increased cost of financing. If you do extend payment terms, this can result in higher accounts payable balances, which will increase your current liabilities.
• Interest payable – as interest rates rise, the interest payable on outstanding debt also increases. So, don’t forget to record this as a liability on the balance sheet until it is paid.

There’s no universal rule that rising interest rates will consistently improve your business’ assets or liabilities. However, you must be aware of the impact that they have on your balance sheet. Without this knowledge, you risk building an inaccurate picture of your firm’s financial health.

How accounts payable automation helps you manage rising interest rates

When it comes to rising interest rates, we want you to be conscious, not concerned. After all, there are smart strategies you can employ to ensure that they don’t affect your business’ financial health – such as those we’ve shared in this article.

However, the smartest strategy is to invest in accounts payable automation. Here are three ways our technology — Quadient AP — can help you handle the interest rate rise and improve your company’s financial health:

1. Efficient cash flow management – AP automation accelerates your business’ invoice processing through smarter payment approval workflows, allowing for more precise control over cash flow. Whether you want to expedite payments or strategically delay them, the choice is yours. This ensures you have sufficient liquidity to meet your financial obligations, without incurring unnecessary interest expenses.
2. Reduced payment errors – the technology significantly reduces the risk of payment errors by automating previously manual tasks. This makes duplicate payments less likely, as well as incorrect payment amounts. These errors can be costly, not only in terms of interest expenses, but also due to the time and resources required to reconcile accounts.
3. Unparalleled financial control – with AP automation, you gain comprehensive and real-time visibility into your finances. The technology is cloud-based, allowing your employees to access it remotely. It’s also centralized, meaning users can monitor every aspect of AP performance through a single, customizable platform. This increases financial control, helping your team to strategically manage payments and eliminate delays.

Of course, there’s plenty more that accounts payable automation offers, but we don’t want to spoil all our surprises! To discover how Quadient AP can boost your business, schedule a demo today.