Next week the United States Federal Reserve Board will meet in one of their eight yearly meetings. This group of monetary experts meets to discuss our country’s monetary policy and set the interest rate that the government charges banks for government funds. Virtually all other rates in the world are then set based on what is referred to as the “Federal Funds Rate”.
While it is national and international news each and every time this board meets, the actions that the board takes can make a big difference in the financial performance of your funeral home and, more importantly, what is left in your pockets after you have made your principal and interest payments on capital projects, including acquisitions.
The Federal Reserve Board will use its power judiciously but, in general, will cut rates to stimulate the economy and raise rates when the economy seems to be moving forward on all cylinders. While we have been in a decade of low rates, created during the great recession of 2008, historically from 1971-2019 the average rate on Federal Funds has been 5.66% with a high of 20% in March of 1980 and a low of 0.25% in December 2008. Currently the Federal Funds rate sits at 2.25% and there is an expectation that the rate may be cut another 0.25% next week.
Just for the record, I am not in favor of cutting rates right now. While I don’t have all the information the Federal Reserve Board has at its disposal, I believe the economy is functioning quite well – not perfect — but quite well. . . .especially when you compare the U.S. economy to other world economies at this time. With the rate currently at 2.25% there is not what I would call enough “powder in the keg” to reverse an economic downturn if one truly became evident. My thought process is that I would like to have that powder there for when it is really needed.
Now that you know my viewpoint, here are three ways that following the Federal Funds rate and making moves based on what has happened in its rates can help your funeral home.
Saving Interest Payments over Time — The Fed rate has been moving upwards for a couple of years now. It moved down at the Feds last meeting in late July and is expected to move down again next week. Theoretically, that means, that with everything else being equal, you should be able to get a lower interest rate on any loans that you have – depending on Fed Funds rate when the original loan was secured.
For instance, if you have a 5.25% loan over a 25 year amortization on a $500,000 loan, you are paying principal and interest of $35,952 per year. If you can negotiate that loan down 1.0% to 4.25% with the same terms you will save about $3500 annually for the 25 year period or a total of over $86,000. If you are a good credit risk, your banker does not want to lose you. Maybe a short discussion with him/her would be worth it if it saves you $86,000. Or, would you rather just let your banker be $86,000 richer?
Low Cost Financing for a Project— Could your funeral or cemetery business improve itself with some type of capital improvement that you thought was too expensive to try? What about adding a crematory to your existing facility? If the Fed rate moves down you will have lower financing costs and if you couple that with what you will save from paying a service to do the cremations, can that move the needle enough to allow for this improvement without leveraging you too much?
A Higher Value for your Business if you Sell — it’s no secret that a funeral or cemetery business is only worth the cash flow that it can generate to a new owner. Unless it is located in a highly desired real estate spot, the sale of your funeral home will generate a multiple of the EBITDA of your business. However, you can move that multiple higher if the cost of financing the acquisition for the purchaser can come down due a lower interest rate paid on any borrowed funds.
It’s also no secret that the most highly desirable operators are getting more value for their funeral homes in this environment of low interest rates (recently a Federal Funds rate of 2.5% or lower). If we see Federal Fund interest rates rise to near historical levels (the 5.66%) mentioned earlier, the high multiples in the acquisition prices will surely go away.
So, when you hear that the Federal Reserve Board meets next week and does something with the rates, don’t just think it has to do with big companies and international finance. Knock that information down into information that can be useful to you in operating your own business. Trust me. . . the best operators take advantage of the information that they can accumulate.