After more than a decade of near-zero interest rates, the normalisation of rates to historically more typical levels has materially changed the economics of working capital management. For many businesses — particularly those that grew during the low-rate era — this shift has implications that haven't been fully worked through in their financial planning.
This post covers the specific ways in which interest rates affect working capital, how to model the exposure, and the practical steps businesses can take to manage the impact.
Why Working Capital Is Interest-Rate Sensitive
Working capital — the difference between current assets and current liabilities — represents the capital the business has tied up in its operating cycle. Specifically: the cash tied up in inventory before it's sold, the cash tied up in receivables before customers pay, minus the credit extended by suppliers.
The working capital cycle is funded by some combination of equity (owner capital), retained profits, and short-term debt (overdraft, revolving credit facility, invoice discounting). When interest rates are low, the cost of funding this cycle is negligible. When rates are higher, the cost becomes material.
A business with €2M of average working capital funded by a revolving credit facility at 7% interest carries an annual financing cost of €140,000 — a cost that was barely visible at 1% (€20,000) two years earlier. That €120,000 difference is real P&L impact.
The Five Ways Higher Rates Affect Working Capital Management
1. The cost of carrying inventory increases
Every unit of inventory on the balance sheet is cash that isn't available for other uses, and if it's debt-funded, it's cash generating an interest cost. At low rates, holding three months of inventory felt relatively cheap. At higher rates, the same inventory level carries a meaningful financing cost.
The practical implication: the optimal inventory level shifts. The economic order quantity calculation that balances ordering costs against holding costs needs to be re-run with a higher holding cost assumption. Businesses that were comfortably over-stocked at low rates may need to reduce inventory levels to justify the carrying cost.
2. The cost of debtor days increases
Allowing customers 60-day payment terms when your cost of capital is 1% is essentially free. At 7%, it costs you 1.2% of the invoice value for that extra time. Across a large debtor book, this adds up.
The implication: it's worth re-examining whether your payment terms are priced appropriately. Are you extending credit to customers who don't need it, or who wouldn't insist on it if you pushed back? Early payment discounts (offering 1–2% discount for payment within 7 days) become worth modelling when the alternative is carrying the receivable at a meaningful cost.
3. Supplier credit terms become more valuable
If debtors are more expensive to carry, creditors are more valuable. Supplier credit is essentially free short-term financing. At low rates, there was little incentive to extend supplier payment terms aggressively. At higher rates, every extra day of supplier credit is worth cash.
Negotiating from 30-day to 60-day payment terms with key suppliers is worth pursuing systematically if your relationships and financial position allow it. The cash flow impact is permanent, not just a one-off timing benefit.
4. The make-or-buy and stock-or-order decisions shift
At low rates, holding safety stock as insurance against supply chain disruption was relatively cheap. At higher rates, the insurance premium (carrying cost) is higher. Businesses need to make a more explicit trade-off between supply chain resilience and working capital efficiency.
Similarly, the economics of holding finished goods versus manufacturing to order change when holding costs increase. Businesses that moved to "build ahead" during supply chain disruption should revisit whether that model still makes economic sense in a higher-rate environment.
5. Access to short-term credit facilities may change
Banks have repriced credit facilities at higher interest rates, and in some cases tightened covenants or reduced facility sizes for businesses whose financial performance deteriorated. A revolving credit facility that was available at EURIBOR + 1.5% (effectively ~1.6% in 2021) may now cost EURIBOR + 2.5% with EURIBOR at 3.5% — an effective rate of 6%.
Review your existing facility terms against current rates and understand when they come up for renewal. Refinancing conversations are better had from a position of strength than when the facility is expiring. A fractional CFO can run that review and the lender conversations if nobody in-house has the time.
Modelling Your Working Capital Sensitivity
To understand your business's specific exposure, build a working capital sensitivity model:
Step 1: Calculate your current working capital — receivables + inventory − payables.
Step 2: Identify how much of this is debt-funded versus equity/profit funded.
Step 3: Calculate the annual interest cost at current rates, and model it at rates +2% and +4%.
Step 4: Calculate your debtor days, creditor days, and inventory days. Model what each metric improvement is worth in cash. For example: if your debtor days are 55 and you could get to 45 days, how much cash does that release? At your current revenue run rate, 10 days' improvement = (annual revenue / 365) × 10.
Step 5: Identify which metric improvements are achievable within 6 and 12 months.
This exercise typically surfaces cash release opportunities that weren't visible when rates were low and the cost of delay was negligible.
Practical Levers for Working Capital Optimisation
Collections: Implement a systematic collections process with defined escalation paths. The single biggest improvement in most businesses' working capital comes from reducing the tail of slow-paying customers. Identify the top 10% of overdue receivables by value and call them.
Invoicing speed: Delayed invoicing is a common, invisible working capital drag. Invoices sent 10 days after delivery add 10 days to your average collection period before the debtor clock even starts. Invoice at or before delivery where possible.
Deposit and milestone billing: For project-based businesses, milestone billing structures that collect cash ahead of or concurrent with cost incurrence are much better for working capital than billing on completion.
Inventory management: Review slow-moving SKUs and dead stock. Inventory that isn't selling isn't just carrying a financing cost — it's also occupying warehouse space and has deterioration risk. Regular markdown cycles to clear slow-moving stock free capital and reduce waste.
Supplier terms: Identify suppliers where payment terms can be extended without damaging the relationship. Large suppliers who are used to 30/60/90-day terms from large customers will often accept extended terms from growing SMBs if asked properly.
Frequently Asked Questions
Does this affect businesses that don't use debt financing? Yes, but less directly. Even equity-funded businesses have an opportunity cost on working capital tied up in their operating cycle — that capital could be earning a return elsewhere. The opportunity cost is now higher because risk-free rates are higher.
When should I review my working capital facilities? Review annually, and proactively before any planned growth that will require more working capital. Don't wait for your facility to expire — start renewal conversations 6–9 months before the maturity date.
Should working capital management be in my board pack? Yes. Working capital metrics (debtor days, creditor days, inventory days, cash conversion cycle) should be tracked and reported monthly. These are leading indicators of cash position and business health.
BB Financial Services Kft builds working capital models and cash flow forecasts that give businesses full visibility into their cash position and the levers available to improve it. Get in touch if your working capital needs a structured review.
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