What: Retailers are facing the end of cheap loans as central banks around the globe are increasing interest rates as they fight the highest inflation in four decades.

Why it is important: Higher interest rates are forcing retailers to make tough decisions on what projects to pursue and where to make cuts.

In the US, the Federal Reserve set its benchmark rate at 4.75% to 5%, a level not seen since 2006, and in the UK, the Bank of England has increased its interest rates to 4.25%.

For consumers, this means less discretionary spending as mortgages are higher and interest rates on credit card balances increase. Retailers are already feeling the pain from this change in consumer behavior, in addition to facing the impact of higher rates themselves.

Debt payments are now a much bigger factor when deciding to open a new store, launch a new advertising campaign, or enter a new market as retailers will either have to scale back their plans or compensate for the high interest payments elsewhere.

An analyst from investment bank William Blair stated that it’s all about capital allocation, as running a levered balance sheet with debt frees up capital to invest, but when debt costs more, the upside isn’t there.

It’s critical for companies who have debt that is due in the near term to assess and understand the needs of the business as they have two main options: refinance at a higher rate or pay down as much as possible. Allocating free cash flow towards debt means less money to go towards growth and improvements, while refinancing can protect cash flow to fund investments which could result in higher returns. Borrowing more is also an option, especially for an urgent problem or can’t-miss opportunity.

Other alternatives to using cash to pay down a loan are debt-for-equity trade, restrictive covenants, or tying favorable loan terms to business performance.

Preserving cash in an economic downturn is critical. One way to increase cash flow is through reducing the amount of inventory commitment. Even a small inventory reduction, 5% or less, can result in saving tens or hundreds of millions of dollars.

Most importantly, retailers need to drive profitability while keeping operations as efficient as possible, as being a good performer makes the questions regarding financing easier to solve.

How retailers can navigate rising borrowing costs