Something Else to Plan for…
The big news this past week was the Federal Reserve raising the interest rate – the Fed Funds Rate - that banks charge each other to borrow. They kicked it up 0.75%, to 1.5%, effectively doubling it.
That’s right. Banks borrow from other banks. And when they do, the Fed Funds Rate is what they pay.
Why do they need to borrow? Well, let’s say escrow closes on Twitter and Elon has to wire $45,000,0000,000 out of his bank account. Unless the bank has $45B in cash, they would have to borrow from other banks to get the cash out to the escrow company. It’s not like the bank doesn’t have the money, it’s just that their cash may be tied up in other investments, and yes, that is a dramatic over-simplification, but you get the picture.
The big, money center banks, like Bank of America, have $350 billion or more of cash and cash equivalents, so it’s generally not a problem for the major banks. The smaller, community banks utilize the Fed quite a bit.
Back to the Fed Funds Rate.
So, the Federal Reserve has raised rates for the banks and consequently increased their borrowing costs.
It also has a direct correlation with what businesses pay banks for their borrowing costs.
Let’s say you have a $2 million loan and you pay the prime rate as published in the Wall Street Journal.
The prime rate had been 3.25% since March 2020.
That rate was based on a 0% to 0.25% Fed Funds Rate; that rate is now 1.5%. That makes the WSJ Prime Rate 4.75%.
For that $2,000,000 loan, your interest costs have increased from $65,000 per year to $95,000.
In case you are counting, that’s a 46% increase. Is it any wonder that borrowing slows down?
For public companies that have debt, it also reduces their net income, which is mostly what the share price is based on. Hence the drop in the stock market.
The good news is that increase also decreases your taxes, everything else being equal.
I guess I’m trying to find the silver lining in that raincloud.
Make all of this a page in your business playbook under the section “what to do when borrowing costs increase”.
Put that section right next to “What to do when my bank will not increase my line of credit”.
Speaking of planning…
I was reminded of planning for contingencies this past week when Kohl’s made headlines for being an acquisition target. That was followed by a LinkedIn post by a business owner talking about their connection with Kohl’s and how thrilled they where to do some quality work for the Kohl’s chain.
It also made me think of another business that was not in touch with its customers and has lost the personal relationship the owner had built over the last 25 years.
If Kohl’s (or any other company), is a significant customer for your business, you should have a very solid relationship with them.
Part of that relationship should include a multiyear contract if possible.
If that’s not possible, then you should be on a first name basis with the decision maker for your customer.
But if your customer gets bought-out, odds are your key contact is gone and with it may be the sweet deal you had with them.
Plan for that under the heading “What to do if we lose any of our top 3 customers”
Other tidbits…
Many companies have overcommitted to inventory trying to hedge against supply chain issues. Look for opportunities to purchase goods when it starts to get discounted.
U.S. manufacturing employment is virtually back up to where it was prior to covid, with some sectors like food manufacturing and chemicals above pre-pandemic levels. Where are those workers coming from??!!
Personal debt levels are going up ever so slightly as banks keep easing personal consumer and residential lending credit standards. Yep, they really are.
Quote of the Week
Donald Lubin was a member of a prominent Chicago law firm in the late 1950s when he got a call from Ms. June Martino, a bookkeeper and corporate secretary of one of his clients. She had a personal legal question unrelated to the business. He got her the answer and refused payment for what he viewed was a simple favor.
Ms. Martino has very grateful and gave him some billable work putting her will together. And he did.
Continued to be impressed, she asked if he would be interested in doing the will for her boss, a Mr. Ray Kroc, the head of McDonalds. Yes, that McDonalds.
Mr. Lubin bonded with Mr. Kroc, joined the Board of McDonalds in 1967 and remained a director for 37 years. And his firm picked up a considerable piece of the legal work for the company.
His quote – “Do even the smallest tasks well, and clients will remember you fondly.”
And you now have your task for the week.
