Debt is a part of business. Bank loans provide manufacturers with the working capital to support expansion, purchase equipment, make facility improvements, add resources, and cover other investments needed to maintain or grow the business. However, loans come at a cost and debt servicing challenges often intensify as interest rates rise. Higher rates lead to increased borrowing costs which can delay or eliminate critical investments. In some cases, it can be the beginning of the end for already vulnerable companies.
But the news isn’t all bad and there is hope amidst these pressing concerns. In this blog we will dive into the impact of high interest rates on the manufacturing sector and explore how technology in the form of production monitoring can effectively alleviate much of the pressure associated with debt servicing.
The Impact of High Interest Rates
An FCC article, Rising interest rates? Use these 2 financial ratios to keep a strong balance sheet, suggests using the Debt-Service Coverage Ratio (DSCR) as a way to gauge a manufacturer’s tolerance for rate increases. Dividing net operating income by annual debt service payments allows a manufacturer to determine the cash available to pay off debt obligations.
Rising interest rates are not the only risk facing the manufacturing industry. As borrowing costs rise, manufacturers find it more expensive to invest in new equipment or expand operations. This leads to a slowdown in production, reduced competitiveness, and even job losses. At the same time, higher interest rates have traditionally suppressed consumer spending, leading to a decrease in demand.
A decline in revenue available to service debt will negatively impact a manufacturer’s financial strength. For example, a 10% decrease in net operating income coupled with a 2% interest rate increase would decrease the DSSR to 1.04 making debt repayment challenging.
A Building Storm
Any hope that the worst is behind us can be put to bed by The Wall Street Journal. An article on the publication’s website reports that, in the wake of a shaky economy, consumer confidence remains low and is placing an even heavier burden on debt-laden manufacturers.
As consumers rethink purchases, production is being softened. The magnitude of this output reduction is reflected in reports that production of household goods such as appliances, furniture, and carpeting was down almost 15% in January 2023 from the previous year. Similarly, steel, iron, and other primary metals production was down 3.6% while machinery production fell by 1.8%. During this same period, output of plastics, food and beverage products, computers, and electronics, also dropped.
“As the Fed continues to hike interest rates, manufacturing is going to be in the crosshairs,” said Barclays PLC Senior U.S. Economist, Jonathan Millar, “It’s hard to see this sector not suffer some sort of a downturn that is more significant than what we’ve seen already.” And Millar’s warnings are being confirmed by independent sources.
- According to surveys by the Institute for Supply Management, new orders for manufactured goods fell for sixth straight months.
- A three-month moving average of Federal Reserve data, shows that manufacturing output is down 1.7% from its post-pandemic peak in May 2022.
- The Commerce Department’s measure of civilian capital equipment orders was down 3.4% in January from its recent high in November 2021, after adjusting for inflation.
Now more than ever, manufacturers must have a strategy to improve their debt/equity, offset lower demand, and service loans. And regardless of type, size, or industry, this should include leveraging production monitoring technology.
By closely monitoring production equipment, resources, and processes, manufacturers can identify inefficiencies, reduce waste, and improve productivity. This makes sound business sense regardless of economic conditions. But in times of low consumer spending and costly borrowing, efficiencies gained through production monitoring can offset much of the costs associated with high interest rates by:
- Identifying inefficiencies: Production monitoring plays a critical role in pinpointing production process bottlenecks and inefficiencies. By promptly identifying and addressing these issues, manufacturers can significantly improve efficiency and reduce costs, easing the burden of debt servicing.
- Reducing waste: Waste can significantly contribute to debt servicing challenges for manufacturers. Production monitoring facilitates the identification of areas where waste occurs. This allows manufacturers to implement targeted strategies to minimize waste, resulting in substantial cost savings.
- Improving productivity: Armed with real-time production data, manufacturers can make informed decisions that effectively boost productivity. Increasing output without the need for additional investments in equipment or labor can help alleviate debt servicing pressures.
- Better maintenance planning: Production monitoring systems offer the advantage of predicting potential equipment failures. This proactive approach enables manufacturers to conduct maintenance in a timely manner, reducing downtime and associated costs, thus positively impacting debt servicing capabilities.
Offsetting Market Volatility
Earlier this year, United States federal officials approved raising their benchmark rate to the highest level since 2007. And if that weren’t concerning enough, the Fed signaled they are likely to raise interest rates again. This makes it imperative for companies to maximize investments to their fullest. And for manufacturers, the answer can be found on the shop floor.
By identifying inefficiencies, reducing waste, improving productivity, and enabling predictive maintenance, production monitoring arms manufacturers with the information to effectively navigate financial storms.
With the ability to optimize operations, manufacturers can mitigate the impact of debt servicing challenges and steer towards financial stability and growth. Embracing production monitoring is a crucial step towards debt servicing resilience and long-term success in the manufacturing landscape.
Our technology is at work within manufacturing facilities across North America, improving efficiency and optimizing equipment investments. Contact us to see a demo of our software and learn how we can help.