How will GST impact your business' working capital?
Working capital management seems to be a chaotic task but it is to be necessarily considered by all the businesses.
Working capital aids in stemming the requirements that arise from the day-to-day operational activities of a firm and is necessary for small and large firms alike, irrespective of their size.
The Indian Economy will always remember July 1, 2017, as a turning point because it's when the Goods and Services Tax came into existence all across the world.
However, there was plenty of speculation and gossip about how GST and its functions would affect businesses, employees, and the entire Indian economic landscape as it was an ambitious announcement.
GST for business was designed with a determination to collect indirect taxes in a legit and transparent way, but small-scale firm owners have not discovered its impact yet.
With the outburst of GST, company owners are all set to adapt to the completely new tax structure.
Optimization of a firm's working capital is another significant component that business owners have to prepare themselves and their business for.
GST for businesses has many implications on the working capital of a firm as well.
We have compiled together a list giving out ways in which SMEs (Small and Medium Enterprises) are affected by the GST based on their business working capital.
What is business working capital?
Business working capital is also termed net working capital (NWC).
It is the difference between a firm’s current assets—such as customers’ unpaid bills/accounts receivable, inventories of raw materials and finished goods, and cash—and its current liabilities, such as debts and accounts payable.
Business working capital is an estimation of a firm’s short-term financial health, operational efficiency, and liquidity.
A company’s positive net working capital is directly proportional to its investment and growth.
A company is likely to face trouble paying back creditors or growing in a case where its current assets do not surpass its current liabilities. The chances of bankruptcy increase.
Importance of business working capital
1. Liquidity management
The finance team of an organization is capable of planning their funds conveniently by systematically analyzing the expenses payable or to be incurred in the near future.
2. Out of cash
An enterprise is likely to face liquidity issues if it works according to inappropriate organized plans of daily expenses.
It may lead to postponing or arranging funds from different sources which creates a bad impression of an organization at the party.
3. Helps in decision making
By properly analyzing the necessity of funds for day-to-day operations, the finance team can aptly manage the funds.
It can also plan accordingly for the availability of funds and available funds.
4. Addition in the value of business
With proper management, authorized personnel can manage all the daily required funds so that they can pay for all the outstanding expenses on time.
It adds to the company's goodwill enhancement and value addition in the market.
5. Helps in the situation of cash crunches
The finance team can prevent the expected situation of cash crunches or crises within the organization by managing the liquid funds systematically. They can pay for their daily expenses on time.
6. Perfect investments plans
The finance team can plan or decide for their investments accordingly by managing the working capital and funds correctly.
They can further invest the wealth to maximize the fund as per their availability.
7. Helps in earning short-term profits
Occasionally, it is found that the organizations keep a bulk amount of wealth as business working capital which is far over and above the demanded criteria of working capital.
Well, by managing the business working capital correctly, those excess funds could be invested for a short span of time. It could add value to the profits of the enterprise.
8. Strengthening the work culture
On-time payment of all the day-to-day expenses and most importantly the salary of the employees brings a good environment to the organization.
It motivates the employees to work harder and strengthen the healthy working environment.
9. Improves creditworthiness of entity
When the organization has sufficiently outlined its working capital requirements, it will make on-time payments to its creditors and vendors.
Paying on time positively adds to their creditworthiness which could arrange their funds for future prospects.
10. Act as guarantor to other enterprises
If an organization manages to create such outstanding goodwill in the market, then it becomes capable of supporting other businesses as well.
The company earns business profits and contracts are met easily as a favor.
11. Good reputation of entity
A company’s good reputation in the market brings a lot to it. Goodwill can be earned by the accomplishment of commitments on time, and timely payment of day-to-day expenses.
These days, everyone wants to join and do business with those parties whose creditworthiness and market goodwill is perfect due to an increase in manipulations and fraud.
How does GST impact working capital?
Service becoming expensive
It is less important to mention that the purposes were and are pretty transparent when GST for businesses was designed and invented, to deteriorate several economic evil practices and to help the businesses in saving their taxes.
The financial after-effects of the Goods and services tax have gradually started showing up and are less in tune with the original purpose and fluctuate from industry to industry.
For example, the services sector was taxed at 12% in the pre-GST era, and is now increased to 15% - additional taxes overall – the increasing load will have to be consumed by the working capital.
Services providers should reconsider their complete plans of the usage and allocation of the available business working capital.
It should search and come up with a legal approach to compensate for the intensified taxation.
Inventory management
GST for businesses has brought about a drastic turn in inventory management.
Previously, businesses used to manage a number of warehouses in several states to eliminate the cross-border taxation expense. The movement of goods from one state to another makes it indeed a costly affair.
The organization had to pay taxes particular to the state every time the goods were shifted to another state.
This puts an extreme load on the working capital of the firm.
With the introduction of Goods and Service Tax, businesses can conveniently manage a number of warehouses in the country and when they transfer goods to a different state, they are required to pay taxes every time goods reach the border.
This aids businesses to cut down on taxes and reduce the stress on their working capital.
Timeline related to tax payment
The tax payment timeline has had a great effect on the business working capital. Goods and Services Tax is imposed at the time of transfer of goods.
However, organizations can demand tax credit only while selling the goods.
This means that the time between the sale of a good and their transfer could consume a lot of time. Businesses are authorized to claim an input tax credit only after the sales.
This creates a bad impact on the business working capital as it declines to a large extent during the waiting period.
Goods are easier to move freely
Several organizations presently manage different warehouses across the globe to avoid the payment of additional taxes for transferring goods across state borders.
Each of these warehouses has to act in accordance with the tax rates and laws of the state in which it’s present.
This pressure of tax compliance increases the expense of operating each warehouse, adding to the firm’s operational costs and therefore its working capital requirements.
Because of the impact of GST, organizations won’t be required to act in accordance with entry taxes, Octroi, or CST, so it will be easier and more convenient to ship goods across the country.
This helps the organizations to run their warehouses more effectively and mark them where it makes the perfect business sense.
GST is imposed during the sale of goods and services
As the impact of GST, tax is imposed upon the transfer of goods, so organizations can’t demand their tax credits until the selling of shipped goods.
This can often take months, during which the paid tax amount won’t reach the firm.
18% is the standard GST rate for businesses.
It could also add expenses for businesses that obtain a bulk of their raw materials from other countries.
Reduced human work
GST’s effect on the Indian economy has given birth to several benefits. One of the major benefits is that human intervention is brought down.
The online taxation process has become less traumatic because it is free from the requirement for multiple interchanges within different departments.
Previously, the process of filing taxes would be very time-consuming for firm owners, thereby bringing down the efficiency levels of the organization.
After the introduction of GST for businesses, all the compliance processes have now been transferred online; this means that registrations, returns, refunds, and payments will all be completed online.
Online registration is done to make sure that owners receive their registration certificates timely, and makes you free from any authorities.
The payments are done on time when the compliance procedures are online. They have low compliance expenses and are transparent. The refunds are accelerated, and it also adds to the greater liquidity (for the business holders).
Benefits of managing business working capital
Business working capital is significant to meet costs and pursue growth. It also helps in depicting the condition of the financial health of the organization.
Working capital is what an organization is left with after separating liabilities from assets.
However, the assets are required to be liquid enough that an organization can sell them right away to receive the funds it requires. It should be a major aim of any business to always possess enough capital with themselves to meet its urgent requirements.
Liquidity is one of the main concerns. It's so necessary for organizations to possess positive capital.
This puts the managers or owner of the firm in a condition to fetch opportunities that come in their way as well as meet the least expected losses such as structural damage from severe floods.
Also, business working capital offers greater flexibility to the owners.
It gives them the authority to invest in different products and services and have dominance over their competitors in the market. It is also capable of offering an essential safety net when sellers take time to pay outstanding invoices.
Devoting attention to business working capital and making sure that it’s always on the positive side also leads to increased profits. It is another major benefit.
Well, this is only possible when a firm’s accounts receivable and accounts payable departments are working at their highest efficiency.
Accounts payable are required to excel in outstanding invoices and ensure timely payments.
However, this makes them subjected to avail the benefit of early-pay discounts sponsored by several businesses.
Accounts receivable requires to track invoices through the pay cycle and notify consumers in case of delayed payment.
Suggested read - Guide on how to raise GST invoice
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FAQs
Business working capital is a financial metric. It is calculated by deducting current assets from current liabilities, as mentioned in the balance sheet of a business.
The formula for the calculation of business working capital:
Working Capital= current assets - current liabilities
Current assets include cash and liquid assets such as marketable securities, accounts and notes receivables, short-term investments, and others.
On the other hand, current liabilities include all those liabilities which are due within an accounting period such as taxes payable, interest payable on loans, accounts payable, and others.
The Goods and Services Tax Act mentions that if your firm’s annual turnover is above Rs 40 lakhs, then you are required to register under GST. The amount limit varies for the hilly regions and the northeastern states. Well, you are advised to register GST for your business so that you can continue the operations legally. It has proved to be beneficial in establishing your business as creditworthy and authentic in the marketplace. GST registration assists in the efficient management of your businesses.
The main difference between working capital and cash flow is that working capital shows a detailed scenario of your firm’s current financial position, whereas cash flow depicts the amount of wealth your firm can gain over a specific period of time. Business working capital gives you a transparent idea related to your company’s strength to pay unexpected expenses, while cash flow is comparatively more progressive. Your firm is capable of generating sufficient cash even if the working capital is weak but its cash flow is powerful. However, weak business working capital can lead to serious financial troubles for your association.
Business working capital can be negative if a firm’s current liabilities are more than its current assets. It can be calculated by deducting current assets from the current liabilities. Working capital shows what a firm presently has to finance its urgent operational requirements, such as accounts receivables, inventory, and obligations to its vendors. Prepaid expenses also come under working capital.
Temporary negative outcomes of working capital are not a bad thing but if it becomes consistent, it can bring several issues to the companies. The firm has to struggle to make deadline meets and have to depend on stock issuances or loans to support their working capital. Business working capital shows the exact financial position of your company. Well, a negative business working capital serves as a red flag for your business.