This document discusses business credit and interest rates. It explains that credit allows businesses to borrow money for assets, growth, and customer billing. Interest rates are the cost of borrowing, and are set by the Bank of England to influence the economy. Changes in rates affect business investment and consumer demand, so businesses must consider their debt levels and cash flows to determine how rate changes will impact them.

1. Business &
Interest
Rates

2. Key topics to consider
• Credit – why businesses need it
• What is an interest rate?
• Who sets interest rates?
• How businesses are affected by
changes in interest rates

3. What is credit?
Credit is about
borrowing – owing
money to others for a
period of time

4. Why do businesses need credit?
• To finance purchase of assets (e.g.
stocks, machinery, computers)
• To allow customers to take time to
pay their bills
• To support the growth of the
business (e.g. new locations, extra
staff)

5. Examples of business credit
• A business uses its bank overdraft
facility – e.g. the bank account goes
£50,000 “into the red” or overdrawn
• A business takes out a bank loan – e.g.
£100,000 loaned over five years
• A business buys goods or services from
a supplier and agrees to pay for them in
30 days – this is known as trade credit

6. How much credit can a business obtain?
It depends on…
• Whether the business is profitable and
is likely to remain so in the future
• The ability of the business to generate a
positive cash flow to allow it to repay
credit
• The strength of the relationship
between the business and its creditors
• The industry or market in which the
business operates

7. What happened in the “credit crunch”?
• Banks withdrew or lowered overdraft
facilities
• Banks refused to provide bank loans, or
made the repayments and interest
charges worse
• Suppliers insisted on earlier payment of
invoices
• Customers took longer to pay their bills

8. What is an interest rate?
An interest rate is the
cost of borrowing
money or the return
for investing money

9. Interest payments & receipts
Interest Paid Interest Received
Paid to bank when
overdrawn
Paid to bank on a bank Paid by bank on cash
loan balances held
Paid to credit card Paid by customers if they
companies are late settling invoices
Paid to leasing
companies

10. The base rate

11. Who sets the interest rate?
The base interest rate in
the UK economy is set by
the Bank of England.
Each month, the
Monetary Policy
Committee of the Bank of
England to decide what
the base rate should be

12. Interest rates & monetary policy
• Monetary policy involves the use of interest
rates and other monetary measures to :
– Influence bank lending
– Control the growth of aggregate demand
– Control the demand for and supply of money
– Influence the external value of the currency
• The Bank of England operates
UK monetary policy on behalf of the government
• The main objective of monetary policy is price
stability and the main policy weapon is interest
rates

13. What has happened to interest rates in the UK?
During the credit
crunch, the base
interest rate has
fallen sharply to as
low as 0.5%

14. Interest rate changes affect the whole
economy
• Exports and imports • Demand for loans
• Balance of payments • Consumer confidence
• Exchange rate • Demand for goods
• Housing market • Consumer demand
• Unemployment • Investment - demand
• Economic growth for capital goods
• Inflation

15. Business and interest rates
• Effect of a change in interest rates on
business depends on:
• The amount that a business has
borrowed and on what terms
• The cash balances that a business holds
• Whether the business operates in
markets that depend on consumer
spending

16. The effect on consumer demand
• The demand for goods and services is likely to
fall as a result of a rise in interest rates :
– Consumers might choose to save rather than spend
– They will be less willing to make credit purchases
– Mortgage holders suffer a fall in discretionary income
following the rise in monthly mortgage payments
• But a rise in interest rates will not impact
equally on all parts of the economy
• It will impact disproportionately on demand for
luxury goods and on demand for goods
purchased on credit

17. The effect on business investment
• Rise in the cost of borrowing will reduce the
profitability of a proposed investment
• Investment will be less attractive because:
– It will cost more to borrow money
– Customer demand will be lower
– The expected return on investment will be
lower
– The payback period will be longer

18. Examples of markets which suffer from
an increase in interest rates
• Housing (mortgages)
• Motor vehicles
• Holidays
• “Big ticket” consumer
goods – e.g. new
kitchens, audio-visual
systems

19. How should a business respond?
• Will the rise in interest rates be
temporary or long term?
• Will the rate rise be followed by
further rate rises?
• To what extent is the business in
question affected?

20. If an interest rate rise is a problem
• Price discounts to stimulate demand
• Cost cutting to maintain margins and
conserve cash
• Reduce capacity – e.g. short time work,
redundancies
• Improve management of working capital
(e.g. destocking)
• Reduce the debt burden
• Cut back on investment plans

21. Banks and interest rates
• Banks pay interest on customer
deposits and they charge interest on
money borrowed
• Banks set their own interest rates but
the minimum they charge is set by
the monetary authorities – i.e. the
Bank of England

22. Interest rates & exchange rates
• High interest rates in the UK (compared with
other countries) will cause an inflow of
capital into the UK
• This increases the demand for sterling and
reduces the supply
• As a result the exchange rate goes up
• A stronger currency will make exports more
expensive (thus reducing volume) and
imports cheaper (thus increasing volume)

23. Keep up-to-date with business
stories, resources, quizzes and
worksheets for your business
course. Click the logo!