One of our creamery’s annual traditions is to develop cash flow projections for the upcoming year on the Tuesday before Thanksgiving. This planning event usually occurs about one month after the company’s strategic planning retreat, so the goals and objectives of all divisions can be incorporated with well-thought-out assumptions.
This year’s cash flow projections will have a different twist. Our business, like many companies, has been fortunate to operate in a period of low, flat interest rates. Now, each business that has debt obligations, particularly those with operating debt on variable interest rates, will be required to adjust as interest rates increase. Let’s examine some of the factors that could trigger an increase in interest rates.
The Federal Open Market Committee (FOMC) has a mandate to ensure full employment and a stable economy concerning economic growth and inflation. With that being said, if the unemployment rate remains in the high 3 to low 4 percent range and wages continue to increase, we can expect additional increases in interest rates.
Next, the U.S. economy has been growing above 3 percent gross domestic product (GDP) since the beginning of the year. With the tax cuts and some relief from business regulation, do not be surprised if the growth rate is sustained. The pace of economic growth is another factor that would be considered prior to a change in interest rates.
Finally, inflation is the wildcard. Tariffs and other conflicts in trade agreements have caused inflation on imported goods. This, combined with wage growth, could bring inflation in the sustained 3 percent range. Higher inflation would be another factor for interest rate deliberations.
The bottom line for the 2019 planning cycle is to expect higher interest rates. One can safely bet that we might see up to three interest rate hikes at 25 basis points each for a total of 0.75 percent increase in 2019. When forecasting your 2019 cash flow, determine how much impact three interest rate increases will have on your bottom line and overall cost of production.
Interest rate increases and their influence on your cost of production should be given more priority in your plans for next year. For a 1,000-acre crop farm with a $1 million operating line of credit, three interest rate hikes would amount to about $7,500 in additional interest cost annually. This would add $7.50 per acre to the cost of production. Yes, interest rates will matter and unfortunately, the rate hikes are dependent on the health of the U.S. general economy, not by the agricultural economy.
Dr. Kohl is Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship in the Department of Agricultural and Applied Economics at Virginia Polytechnic Institute and State University. Dr. Kohl has traveled over 8 million miles throughout his professional career and has conducted more than 6,000 workshops and seminars for agricultural groups such as bankers, Farm Credit, FSA, and regulators, as well as producer and agribusiness groups. He has published four books and over 1,300 articles on financial and business-related topics in journals, extension, and other popular publications.