VAT and Your Business's Cashflow

If you run a small business, or if you’ve read the other article in our series, you're probably becoming very familiar with VAT and how it affects your bottom line. But did you know that VAT can also have a significant impact on your business's cashflow? In this final article in our series on VAT, we'll explore how VAT works, and how it can impact your cashflow as a small business owner.

Introduction 

Before we get down and dirty, let’s quickly recap on what VAT actually is.  VAT is a tax that's charged on most goods and services in the UK. It's calculated as a percentage of the value added to each stage of production and distribution, and it's typically passed on to the end consumer. For example, if a business sells a product for £100 and the VAT rate is 20%, then the VAT charged would be £20, making the total price of the product £120. 

VAT is collected by businesses on behalf of the government, and it must be paid to HMRC on a regular basis. The amount of VAT that a business pays or receives depends on the difference between the VAT charged on sales (output VAT) and the VAT paid on purchases (input VAT).

How VAT Affects Cashflow 

The timing of VAT payments can have a significant impact on a business's cashflow. When a business makes a sale, it must charge VAT to the customer and collect this VAT on behalf of HMRC. This means that the business is effectively holding onto this money until it's time to pay it to HMRC. 

For some businesses, this can be a drain on cashflow, especially if they have tight margins or slow-paying customers. It's important to remember that VAT is a tax on turnover, not profit, so even if a business is not making a profit, it still needs to pay VAT. 

On the other hand, if a business incurs VAT on purchases, it can claim this VAT back from HMRC. This can help to offset the VAT paid on sales, but it's important to remember that this refund is not immediate. VAT refunds can take several weeks or even months to process, which can also impact cashflow. 

Understanding the nature of VAT is essential for small business owners, and one helpful way to think about it is as a tax that's collected by the business on behalf of HMRC. It's important to remember that VAT doesn't really belong to the business, but rather it's a tax that's charged to the end consumer and collected by the business as a middleman. 

This means that businesses need to manage VAT payments as a separate item from their own revenue and expenses. While the VAT charged on sales does increase the total amount of money that a business receives, it's important to remember that this money will eventually need to be paid to HMRC.

Managing VAT Payments

To manage the impact of VAT on cash flow, small businesses need to plan ahead and keep accurate records. One approach is to forecast VAT liabilities in advance, so that businesses can set aside funds to cover VAT payments. This can be particularly useful for businesses that have regular VAT payments, such as those on the Standard VAT scheme. 

Another option is to use a VAT scheme that simplifies VAT accounting and helps with cashflow management. For example, the Flat Rate Scheme allows businesses to pay a fixed rate of VAT based on their industry sector, which can reduce the administrative burden of VAT accounting. This can also help to simplify cashflow management, as businesses know exactly how much VAT they need to pay each quarter. 

Cash Accounting Scheme is another VAT scheme available for businesses. This scheme allows businesses to account for VAT on the basis of cash received and paid rather than on the tax point of supply. It can help businesses with cash flow issues by reducing the VAT they pay upfront on their sales.

Planning for VAT 

It's also important for businesses to plan ahead for VAT and seek professional advice if necessary. Accurate record-keeping is essential for managing VAT payments and avoiding penalties or interest charges. Businesses should also be aware of any changes to VAT rules, such as those related to Brexit, and take steps to comply with these rules. 

VAT can have a significant impact on a small business's cashflow. Managing VAT payments and refunds is essential for maintaining good cashflow and avoiding cashflow issues. By planning ahead, using VAT schemes, and seeking professional advice when necessary, you can begin to get better control of your cashflow.

Nothing on this page is intended to be or should be construed or taken as accountancy, investment, tax or any other kind of advice. We recommend individuals and companies seek professional advice on their circumstances and matters.